Eurosystem’s bond holdings may hamper market functioning – paper

A working paper published by the Netherlands Bank investigates the effect of the Eurosystem’s unprecedentedly high holdings of bonds on repo markets.

Eurozone national central banks greatly increased their bond holdings in response to the Covid-19 pandemic, to a maximum of €1.9 trillion ($2 trillion). In the paper, Tomás Carrera de Souza and Tom Hudepohl use granular data from the Eurosystem’s Money Market Statistical Reporting database to analyse the impact.

The authors say the European Central Bank carried out the intervention to stabilise markets and restore confidence. It may have achieved those aims, they say.

But they find it also had unintended consequences, including making it hard for private institutions to buy certain types of asset. “This collateral scarcity may hamper a smooth functioning of repo and underlying bond markets.”

The authors find that both marginal purchases of government bonds and aggregate holdings “have a significant downward impact on repo rates”.

The paper also investigates the impact of the Eurosystem’s Securities Lending Facility. This facility makes bonds purchased by the European Central Bank available for securities lending by national central banks in the Eurosystem.

They find this “alleviates the downward pressure on repo rates for scarce bonds”. But “it does not fully compensate for the downward pressure created by purchases”, they say.