Questions and answers about the asset purchase programmes of the euro area central banks

The expanded asset purchase programme (APP) is designed to help the European Central Bank in its task of keeping inflation at 2% over the medium term. Asset purchases can provide a stimulus to an economy if the traditional monetary policy measures of a central bank such as open market operations, standing facilities and reserve requirements for credit institutions are not working as planned and it is lending to commercial banks at interest rates close to zero, or even at negative rates for long-term refinancing operations. Asset purchases let euro area central banks lower the yield on bonds and this leads investors to put their money elsewhere, which should improve the financing options available to companies and households. This should encourage investment and consumption in the euro area and help keep inflation in line with the target of the Governing Council of the European Central Bank.

The assets purchased under the expanded asset purchase programme are covered bonds, asset backed securities, public sector bonds issued by governments of the euro area and European institutions, and investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area.

The European Central Bank and national central banks buy the assets. As this is a monetary policy measure, the money for the purchases is issued by the central banks.

The national central banks divide the purchases amongst themselves using the Eurosystem capital key. Since 1 January 2024, Estonia’s capital key is 0.2980%.

The euro area central banks generally buy sovereign bonds from their own country, but the bond issues of some smaller countries and the volumes of their bonds on the market are limited. In these cases the national central banks make alternative purchases, usually by buying bonds from European institutions like the ESM, the EFSF, the EIB or the EU.

Bonds are purchased that have a remaining maturity at the moment of purchase of between one year and thirty years.

The main restriction is that central banks may only buy the sovereign bonds from the secondary market. In this case private investors have shown themselves ready to risk their own money, meaning that the risks and reasonable return of the bonds being bought have been accounted for. If the central banks were to buy the bonds directly from the governments, it would be a case of monetising of government debt, and that is prohibited for European central banks.

A second restriction is the limit on issuance, as euro area central banks may only buy up to 33% of one issue of bonds. This means that a central bank can only buy one third of each individual issue of government bonds from the secondary market. This limit applies to all the bonds bought by central banks of the euro area, including bonds that were purchased earlier.

A third restriction is a limit of 33% for each issuer. This means the central banks can only buy the 1-30 year bonds of those states where less than one third of all the bonds are held by central banks of the euro area. The limit on the purchases of the bonds of European institutions is a little higher at 50% of each issue and each issuer. Both limits apply to the nominal value of the bonds, meaning that the central bank cannot buy more bonds even if their market price falls.

A fourth restriction says the central banks can only buy bonds that the central banks are usually prepared to accept as collateral when commercial banks take monetary policy loans. An exception is made for countries that have requested a programme of assistance from the European Union. The bonds of those countries can only be bought if they comply with the terms of the programmes, and they may not be purchased while the assistance programmes are under review.

The central banks of the euro area can buy investment-grade bonds with a rating of at least BBB or equivalent denominated in euros and issued by euro area companies other than banks, of the sort that the central banks of the euro area generally accept as collateral when a commercial bank takes a monetary policy loan from a central bank.

The same limits apply for purchases of bonds issued by public sector enterprises as for purchases of sovereign bonds. Up to 70% of an issue of bonds by private sector companies can be purchased.

Bonds are purchased that have a remaining maturity at the moment of purchase of between six months and thirty years.

Corporate bonds can be bought from the primary or secondary markets. Bonds of public sector enterprises are only bought from the secondary market following the same principles used for sovereign bonds.

From June 2015 to May 2016, Eesti Pank had a special exemption allowing it to buy the bonds of the state-owned transmission system operator Elering for the public sector portfolio. From June 2016 the central banks of the euro area have been able to buy corporate bonds as part of the asset purchase programme. The Estonian companies whose bonds they could buy were Elering AS and Eesti Energia AS. Six euro area central banks that specialise in this class of assets have bought the corporate bonds, the central banks being those from Belgium, Germany, Spain, France, Italy and Finland. The Finnish central bank bought the bonds of the two companies from June 2016, but the euro area central banks do not publish a breakdown of their bond purchases by company. The income and risks from the purchases of corporate bonds are shared between all the central banks of the euro area using the capital key of the Eurosystem, which gives Eesti Pank a share of 0.2980%. It should be remembered that the amount issued in bonds by Estonian state-owned companies is extremely small in the context of the purchase programmes. The euro area central banks can buy a maximum of 33% of each issue from the secondary market.

Eesti Pank's participation in the Eurosystem asset purchase programmes changed in 2020.

Eesti Pank previously only participated in the public sector purchase programme (PSPP), where purchases of bonds of supranational European institutions were made in proportion to the capital key, because the Estonian government had not issued any bonds that met the rules of the purchase programme requiring maturity of 1-30 years. From June 2020, the central bank started to purchase the bonds of the Estonian government. The risk of the government bonds is not shared with the Eurosystem and is borne by Eesti Pank alone.

The bank also started to participate in the third Covered Bond Purchase Programme (CBPP3) in 2020, though it was first announced in 2014. Commercial banks in Estonia issued their first covered bonds backed by the loan portfolio in Estonia in 2020, and Eesti Pank purchased them for monetary policy purposes.

The Governing Council of the European Central Bank decided in March 2020 to provide additional support for the economy in the euro area during the crisis period of the pandemic, to stabilise financial markets and reduce fragmentation. This was all done for the sake of price stability. Net purchases under the pandemic emergency purchase programme (PEPP) were made from March 2020 until March 2022 for a total value of 1.7 trillion euros.

Under the pandemic emergency purchase programme launched in March 2020, Eesti Pank bought Estonian government bonds, bonds of European institutions, and covered bonds. The same asset classes will be held during the refinancing phase.

The technical construction of the purchase programmes is similar, meaning that the assets are purchased by the European Central Bank and the central banks of the euro area member states in proportion to the capital key, and the public sector bonds are only purchased from the secondary market. The risks are shared for all bonds except sovereign bonds.

The asset classes that are purchased in the portfolios are similar, but the emergency purchase programme temporarily allowed sovereign bonds to be bought with 70-day maturity instead of the one-year maturity of the APP, and exceptionally allowed Greek sovereign bonds to be purchased. Corporate bonds can be bought in the PEPP portfolio with 28-day maturity, while the APP sets maturity at six months.

The PEPP is a more flexible programme than the usual asset purchase programmes, as it allows purchases to be varied over time and over countries according to need.

The tapering of the purchase programmes in 2022 was also similar. Net asset purchases under the PEPP ended in March 2022 and under the APP in June.
At the same time, the repayments of the principal in the APP portfolio ended in April 2023, but for the PEPP these will last up to the end of 2024.

Net asset purchases under the asset purchase programmes ended for the APP in June 2022 and for the PEPP in March 2022. This reduced the monetary policy support from the European Central Bank to the economy. This was because the economic circumstances had changed and inflation had risen very high. The war started by Russia in Ukraine pushed any decline in high inflation far into the future, and so the Governing Council of the European Central Bank had to adjust the course of monetary policy to reduce inflation in the euro area. This reduction in inflation could only be limited because the central bank has few ways to intervene reasonably when the majority of the factors causing the high inflation of that time were beyond its control, as prices have risen for geopolitical reasons for energy and fuels, raw materials, and food, while there are problems in supply chains.

In December 2022 the Governing Council of the European Central Bank decided to start normalising the Eurosystem’s balance sheet from the beginning of March 2023 and in June decided to stop reinvestments from July. In this way, the central bank’s footprint can be reduced even more in the bond markets, which hopefully will nudge the long-term interest rates higher. It boosts economic activity, thereby slowing down inflation as investment decisions are foremost affected by long-term interest rates. It is consistent with the overall monetary policy strategy and stance, helps to preserve market functioning and maintains firm control over short-term money market conditions.

In December 2023, the Governing Council of the European Central Bank decided that from July to December 2024, the reinvestment volume in the portfolio would be on average 7.5 billion euros less each month, and reinvestments would cease at the end of 2024. The purpose of the PEPP was to support the euro area economy and financial markets during the COVID-19 crisis. The cessation of portfolio purchases is part of a normalising in monetary policy and the Eurosystem's comprehensive balance sheet contraction.

The risks from the purchases of covered bonds, asset backed securities, European institution bonds and corporate bonds are divided by the capital key of the European Central Bank, so Estonia has 0.2980%. The capital key is used in the same way to share out the risks from the purchases of the European Central Bank, as the national central banks of the euro area are all shareholders in the European Central Bank under the capital key.

It has been agreed exceptionally that each national central bank is responsible for the risks of the sovereign bonds bought with its own balance sheet.

The Governing Council has not yet decided on whether or not the assets will be sold after the end of net asset purchases.

Purchases of assets are no substitute for structural reform as they can only be used to boost economic activity over the short term. The purchases of sovereign bonds make it a little cheaper for governments to borrow and so it is easier for euro area governments to finance their spending by borrowing. This could lead to a loosening of fiscal policy and to structural reforms being postponed. To avoid this, it is extremely important that all the countries in the euro area abide by the European fiscal rules and that attention continue to be focused as much as it has been on the reforms that are vital for the sustainability of economic growth.

Large-scale purchases of bonds could pose a threat to financial stability because the risk of price bubbles forming in some markets would be raised. To counter this, the central banks of the euro area observe carefully how the bond purchases affect financial stability. It is not necessary to change the monetary policy of the whole euro area if bubbles start to appear in asset prices in some countries. Local risks should be managed by measures taken in local economic policy such as requirements for banks to hold additional capital or loan limits that apply to the real estate sector. Single banking supervision in Europe also helps by identifying risks in individual large banks better than before. It is extremely important that all possible measures are taken in every member state to safeguard financial stability because if instability emerges, it can quickly pass from one country to another.

The bond purchase programme should not permit governments to increase their sovereign debt by issuing new bonds. The financing of every country in the European Union must abide by common rules that do not allow large budget deficits. Normal practice for issuing bonds is that the majority of countries issue new debt to service their old debts, meaning that as the maturities of the bonds arrive, new bonds are issued to pay back the old ones. However, it was noticeable, especially during the Covid-19 pandemic, that the debt burden of governments increased in order to boost the economy more during this difficult period. Since asset purchases stopped being made under the asset purchase programmes in 2022, the growth in the debt burdens has slowed. It is important to remember that the prohibition of monetary financing by governments means that the central banks of the euro area only buy sovereign bonds from the secondary market. For more details see the website of the European Central Bank.

The monthly purchase volumes under the asset purchase programmes are always published on the Eesti Pank website. If the Eesti Pank balance sheet increases significantly with the programme, there is an increase in risk too. The Executive and Supervisory Boards of Eesti Pank assess the risk buffers and can increase them if needed. Eesti Pank had capital buffers of about 486 million euros at the end of 2022, which was a lot less than the relative average for central banks in the euro area. The Supervisory Board has announced as a long-term goal that the relative level of capital of Eesti Pank should rise to the average level of the central banks of the euro area, as the balance of risks to capital of the Eurosystem as a whole is considered when joint monetary policy decisions are made. Bonds bought under the programme are shown as an amortised cost, meaning that changes in their market price do not affect their value on the balance sheet. Any differences between the market value and the book value are recorded as profit or loss when the security is sold. The market prices of bonds with maturities of over a year issued by several countries with high credit ratings are above the amount they will pay out at maturity. Buying such bonds is possible, and this would mean there would be negative yield for the central banks. The earlier principle was that only public sector bonds could be bought if needed if the negative yield fell below the European Central Bank's deposit rate; that rate was -0.5% from September 2019 to July 2022 and the current rate can be found on the ECB website. The Governing Council decided in September 2019 to extend that principle to the private sector bonds as well.