How might the ECB chip away at the promissory note deal?

With the ECB president this morning stating that he is examining “further” the deal on the promissory notes which was reached last week, this blogpost looks at what is likely to be the weakest point, given present low interest rates, in the deal – the discretion of the central banks to stop accepting the bonds as collateral for loans.

In the Dail this week, both the Sinn Fein and Fianna Fail finance spokespersons asked Minister for Finance Michael Noonan to provide more detail on this aspect of the deal, presumably to better understand the circumstances in which one of the most advantageous aspects of the deal – the ability to issue government bonds against which the ECB is lending cash at its main interest rate, currently 0.75% per annum.

Alas, Minister Noonan has not been very forthcoming and responded one question about when the bonds would be sold to the open market, with the nebulous “as soon as possible, provided that conditions of financial stability permit” and to the other question he said the bonds would be sold when “a sale is not disruptive to financial stability. The limits of the option to exchange will be the amounts of the mandatory sales and the option lies with the Central Bank as a right but not an obligation”

This is worrying because if the ECB comes under pressure to provide a similar arrangement to other countries which might threaten to open the floodgates to monetary financing, or if some of the northern European countries get antsy about the prospects of the floodgates being tested, then we might find pressure from the central banks, the ECB and the Central Bank of Ireland, to sell the €25bn of bonds into the market.

The full parliamentary questions and responses are here. Deputy Doherty’s question is from Wednesday, Deputy McGrath’s from Thursday.

Deputy Pearse Doherty: To ask the Minister for Finance if he will confirm the maximum period for which the Central Bank of Ireland may hold any sovereign bond issued as part of the proposed bond issued as part of the proposed new scheme to substitute the promissory notes provided to the Irish Bank Resolution Corporation with sovereign and National Asset Management Agency bonds; and the factors that will affect the period for which the Central Bank has discretion in any decision to hold the sovereign bonds..

Minister for Finance, Michael Noonan: The Central Bank have undertaken that minimum of bonds will be sold in accordance with the following schedule: €0.5bn by the end of 2014, €0.5bn per annum from 2015 to 2018, €1bn per annum from 2019 to 2023 and €2bn per annum  from 2024 onwards.

This schedule of mandatory sales would exhaust the portfolio in 2032.  The bonds will be placed in the Central Bank’s trading portfolio and sold as soon as possible, provided that conditions of financial stability permit.  The disposal strategy will maintain full compliance with the Treaty prohibition on monetary financing.

Deputy Michael McGrath: the circumstances under which the Central Bank of Ireland will be permitted to exchange a portion of the new floating rate bonds issued under the revised promissory note arrangement for fixed coupon bonds; and if he will make a statement on the matter.

Minister for Finance, Deputy Michael Noonan: The Central Bank will sell these bonds but only when such a sale is not disruptive to financial stability. The limits of the option to exchange will be the amounts of the mandatory sales and the option lies with the Central Bank as a right but not an obligation. The Central Bank have undertaken that minimum of bonds will be sold in accordance with the following schedule:-

– €0.5bn by the end of 2014;

– €0.5bn per annum from 2015 to 2018;

– €1bn per annum from 2019 to 2023 and €2bn per annum from 2024 onwards.