To the max

ECB's corporate bond plan is powerful but risky

Forget quantitative easing: the European Central Bank (ECB) may buy corporate bonds instead of gorging on sovereign debt, as partisans of an all-out war on deflation advocate. The move could lower companies' and governments' borrowing costs, and stimulate securitisation. It would also fuel moral hazard, and be as controversial as QE. But the central bank's pledge to fight deflation would be more credible.

Reuters' report that the ECB is mulling an ambitious corporate bond-buying programme highlights the central bank's size problem. To revive Europe's deflating economy, ECB President Mario Draghi has promised to grow the ECB balance sheet by a third, to euro 3 trillion, through long-term loans to banks, coupled with covered bonds and asset-backed securities acquisitions.

The snag is that hitting the euro 3-trillion target could be hard with secured debt only, without causing a markets breakdown. Economists had assumed that the ECB was boxing itself in to buy sovereign debt, in spite of fierce German opposition. Adding corporate bonds to the basket will make the euro 3-trillion goal more credible.

Corporate purchases would not only help the balance-sheet policy. They would bring down bond yields. Companies would lock in cheaper funds, which would give them capacity to invest. Market players would be enticed to lend to riskier or smaller companies, or buy securitisations - the kind that the ECB wants to revive. Peripheral sovereign bond yields would also fall.

Yet, corporate purchases are no panacea. The ECB can't argue that the market is dysfunctional: spreads on A-rated corporate bonds are about 50 basis points (bps), below the 60 bps long-term average, according to UniCredit. Goading on risk-taking may encourage reckless investment.

To get a real boost, the ECB would need to buy risky debt. If it just bought debt rated double-A and above, it would be constrained by the size of a market of only euro 172 billion, according to Citigroup. Moving down to triple-B securities would increase the pool to over euro 1 trillion. In other words, hitting the balance sheet target may involve taking risk, or distorting markets.

The message that the ECB may embark on corporate purchases - or is even considering it - signals that it is ready to push monetary policy to the limit - and that Mario Draghi's 2012 "whatever it takes" promise was no idle boast.