LONDON: ECB bond-buying appears to be losing its potency in Portugal just when the country most needs the backstop it provides.
Portugal's economic growth is lacklustre, its banking sector weak and its coalition government at odds with Brussels over the budget deficit. To top it all, jittery markets are counting down to a vital ratings review on Oct. 21.
DBRS is the last major ratings agency to give Portugal the investment grade rating it needs to qualify for the European Central Bank's bond-buying programme.
Last month DBRS warned pressures were building on Portugal's creditworthiness, stoking concern about the ratings outlook.
ECB asset purchases, which have topped the 1 trillion euro mark, help contain volatility at times of heightened risk aversion and uncertainty -- for instance in the days after June's shock decision in Britain to leave the European Union.
But the central bank has been buying fewer bonds in Portugal than its rules allow because it faces a scarcity of eligible securities, in effect reducing the impact of its purchases.
While the ECB also faces a scarcity of eligible bonds in countries such as Ireland, Finland and Germany, Portugal is especially vulnerable, analysts say.
"The QE safety net is becoming thinner for Portugal," said Richard McGuire, head of rates strategy at Rabobank. "Slow growth, a less than efficient governing arrangement and the looming DBRS review are challenging sentiment at the very juncture that the alternative demand that might have been present via QE is ebbing."
UNDER PRESSURE
ECB rules mean the central bank cannot own more than 33 percent of any single bond issue or of a country's total debt.
Deutsche Bank estimates ECB purchases of Portuguese government bonds amount to 1.5 billion euros a month, a reasonably significant amount relative to the 112 billion euro Portuguese bond market.
ING senior bonds strategist Martin Van Vliet reckons the ECB already owns 27 percent of Portuguese bonds. "If they buy at the pace they should buy they will run out of eligible Portuguese bonds by the end of the year," he said.
UBS estimates that purchases of Portuguese bonds have been below the ECB's monthly targets for five successive months. The pressure on Portuguese bonds has been exacerbated by signs the ECB is in no rush to address bond scarcity.
Ten-year yields have spiked to their highest levels in 2-1/2 months since the ECB said on Sept. 8 it did not discuss an extension to bond purchases, upending market expectations for an extension or tweaks to address a shortage of eligible bonds.
"Most people assumed the ECB would tackle those scarcity issues at the September meeting and they didn't," said Mizuho strategist Antoine Bouvet. "We are heading into a period of more volatility for peripheral bonds and that is especially true for Portugal."
The Bank of Portugal, which buys Portuguese bonds for the ECB's asset-purchase programme, said this week that purchases of public debt for QE are not close to reaching any limits and will continue until at least March 2017 - when the scheme is scheduled to end. It said the programme's implementation is adapted in a flexible manner to guarantee monthly purchases of 80 billion euros across the euro zone.
The ECB, which buys bonds in proportion to the size of each country's economy in the so-called "capital key", held almost 21 billion euros of Portuguese debt at the end of August.
The central bank is considering options to ensure the smooth running of the assets it buys and is not expected to unveil any tweaks or an extension to QE until December.
Until then, analysts say the ECB is likely to keep buying less Portuguese debt than the capital key implies, reducing the effectiveness of the scheme in Portugal.
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