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As ECB ramps up QE, its stake in government bond markets may double

By Dhara Ranasinghe

LONDON (Reuters) - Expanding QE could see the European Central Bank owning up to 25 percent of the 7 trillion euro government bond market, analysts estimate, exacerbating worries about bond scarcity and thin market conditions.

It could also hold as much as 10 percent of top-rated corporate debt in the euro area after announcing this month it will include bonds of investment-grade non-financial firms in its asset purchase scheme from the second quarter. The ECB has said it will increase its bond-buying by 20 billion euros (£16 billion) to 80 billion euros per month from April.

These measures, aimed at boosting growth and inflation in the euro zone, look set to squeeze already tight bond market liquidity and push yields lower.

"If you assume that the ECB will own 22-25 percent of the (government) bond market, then the free float of bonds available goes down," said Nicolas Forest, global head of fixed income management at Candriam Investors Group. "The fact is that quantitative easing has deteriorated bond market liquidity."

Analysts estimate the bulk of the additional purchases will be in the larger sovereign market, just as budget deficits and debt issuance have fallen from post-crisis peaks.

The central bank owns roughly 10 percent of the euro zone government bond market and that will probably rise to 20 percent next year, according to JPMorgan Asset Management.

Commerzbank strategist Rainer Guntermann said the ECB currently spends about 44 billion euros a month on government and agency debt and that this will rise to about 60 billion when total monthly purchases rise to 80 billion euros.

Since the ECB is only expected to start buying corporate bonds by the end of June, the interim period is expected to see purchases focused on government bonds.

BNP Paribas expects net government bond issuance, once ECB buying is taken into account, to fall a further 132 billion euros to minus 387 billion this year, pressuring yields lower.

And while pressure on the market has eased as short-dated bonds have rejoined the eligible pool of assets after the ECB cut its deposit rate to minus 0.40 percent, bonds are likely to remain scarce for both the ECB and investors.

"The focus of this debate has been Germany, and how long the ECB can keep buying German government bonds according to the ECB capital key," BNP Paribas said in a note, referring to limits on the share of a country's bonds the ECB can buy.


NEW KID ON CORPORATE BLOCK

The prospect of the ECB buying corporate debt, meanwhile, has pushed yields down sharply and unleashed a wave of issuance.

With details of the corporate bond-buying scheme still unclear, analysts' estimates on the market impact are based on assumptions such as the exclusion of euro-denominated bonds issued by U.S. firms and whether the financial arms of multi-nationals will be included.

Analysts expect the ECB to buy 3-10 billion euros a month of corporate debt.

"Assuming they'll stop the QE programme in March 2017, our guess is that they might end up owning 8-10 percent of outstanding corporate bonds," said Martin Van Vliet, senior rates strategist at ING.

ING estimates outstanding investment-grade corporate debt, excluding euro-denominated bonds from non-euro zone corporates, will be worth around 1.2 trillion euros in January 2018.

RBC expects the ECB to buy around 5 billion euros a month of corporate debt, amounting to about 50 billion euros by March 2017.

"With the ECB in the market and liquidity still elusive, we reckon that the landscape will be one of a constant grind tighter in spreads," RBC chief European macro strategist Peter Schaffrik said.


(Reporting by Dhara Ranasinghe; Editing by Nigel Stephenson and Catherine Evans)