LONDON/MILAN (Reuters) - The European Central Bank is expected to absorb less than 15 percent of Italy’s bond issuance in 2019, down from around 50 percent in 2017, a new challenge to Rome which will find itself relying on the private sector to fund its borrowing.
All 19 euro zone states will have to adjust to life after ECB quantitative easing, which ends this week, but the pain is likely to be felt most acutely in Italy — one of the biggest beneficiaries of the more than three-year long ECB bond-buying programme.
Just how difficult it can be to entice new buyers was highlighted last month, when Italian institutions and retail mom-and-pop buyers showed scant interest in an inflation-linked bond offer — a development that might have encouraged Rome to seek a compromise with the EU over its contentious 2019 budget.
Italy expects to issue 250-260 billion euros ($281-$293 billion) worth of medium-to-long-term debt.
The ECB will absorb around 14 percent of Italy’s gross bond issuance in 2019, Goldman Sachs bond strategist Matteo Crimella estimates, referring to debt with a maturity of more than a year. That compares with close to 50 percent and 26 percent of gross issuance in 2017 and 2018 respectively, he said.
Instead, from next year, ECB bond buying will happen in the form of reinvesting funds from maturing bonds it holds.
According to Goldman estimates, ECB buying as a percentage of gross issuance next year will be the lowest in Italy out of the euro zone countries it tracks.
“The (Italian) funding numbers are elevated but by no means exceptional,” said Luca Cazzulani, deputy head of fixed income Strategy at UniCredit.
“But investors’ confidence will be key: next year, net funding will have to meet demand from private investors as QE support will come to an end.”
Cazzulani sees upcoming auctions as a “real test” of market appetite. That’s because no medium- to long-term debt matures next month, in contrast to January 2018 when around 15 billion euros worth of bonds came due.
ING estimates Italy will issue some 27 billion euros of bonds in January - its heaviest month for 2019 supply.
The ECB currently owns about 20 percent of the Italian bond market and as in other countries, Rome will continue to see ECB bond purchases because of reinvestments. These should total around 30 billion euros in Italy in 2019, 37 billion euros in Germany and 27 billion euros in France.
But while Italy benefited from ECB over-buying in the past, it now stands to lose out as the ECB adjusts its bond holdings to bring them “into closer alignment” with each country’s share in the capital key, which was recently updated.
That would see the ECB reducing holdings of bonds from Italy, France and Spain by nearly 90 billion euros if it were to mirror its shareholder base strictly, according to Reuters calculations based on ECB data.
On the bright side, however, sentiment towards Italy has improved as Rome dodged a damaging budget row with the EU.
The EU said on Wednesday it has reached a deal with Italy on the 2019 budget which allows the euro zone’s third biggest economy to avoid disciplinary action.
That has allowed the Italian/German 10-year bond-yield gap — the premium investors demand to hold Italian risk — snap back below 300 basis points.
And Italy is not the only euro zone country planning to sell more bonds next year — Germany too has said its issuance will rise.
But Italy’s economy is in far weaker shape and that means its budget deficit could rise by more than anticipated now, say analysts. As QE ends, these fundamentals come back into focus, meaning investors will be more picky about whose bonds they buy.
“If you didn’t have the political situation and an underlying weak economic situation it would be easier for Italy. But the combination of having the political cloud hanging over Italy means the ECB stepping away is going to have more impact than on other markets,” said Patrick O’Donnell, investment manager at Aberdeen Asset Management in London.
Arnaud-Guilhem Lamy, a portfolio manager BNP Paribas Asset Management, said one option for Italy is to woo back retail investors who in the past snapped up a significant chunk of Italian debt.
“In the past five years their share decreased sharply so that’s a potential buyer for the Italian state,” he said.
He noted that although demand for the recent BTP Italia offer was weak, that was an inflation-linked bond which tends to be harder to sell than a conventional issue.
An inflation-linked bond is a more niche product so a more conventional bond tends to go down better with investors, especially as these conventional bonds tend to be very liquid.
Italy’s relatively high yields could also lure foreign investors if they are persuaded the budget row is over. Japanese investors sold German and French bonds and bought Italy in October, latest data shows.
Reporting by Dhara Ranasinghe and Giulio Piovaccari in Milan, Additional reporting by Hideyuki Sano in Tokyo and Sujata Rao in London; Editing by Sujata Rao and Jon Boyle