By John O'Donnell
FRANKFURT (Reuters) - The European Central Bank is examining whether to buy municipal bonds of cities such as Paris or regions like Bavaria, according to people with knowledge of a possible extension of its one-trillion-euro-plus money printing scheme.
This regional bond buying could be one in a series of measures to be rolled out in the coming months, although one of the sources said time was short for a full launch in December and that this would likely come by March next year.
The ECB declined to comment.
Despite the ECB's scheme of quantitative easing (QE) to buy chiefly state bonds, the euro zone's economy is growing only modestly and the central bank is urgently considering what more it can do to improve it and stagnant price inflation.
As part of preparations for the next rate-setting meeting of policy-setters on Dec. 3, ECB officials are now analyzing whether and how to extend its shopping list to municipal bonds, issued by, say, Madrid or Mainz, or a federal German state.
"You have big markets, such as Spain and Italy. France has a well developed market," said one person.
According to data from Thomson Reuters IFR, almost $500 billion of bonds issued by European cities and regions are in circulation. The regions have sold more than $76 billion of bonds over the last year.
The city of Paris, for example, has borrowed 4 billion euros ($4.3 billion) in total through such bonds. It recently sold a bond of 300 million euros.
The source said that while some cities were risky, they had the fallback of central governments. Municipal bonds typically have a lower credit rating than governments. It is a fragmented market in Europe, with many small issues.
"Some cities in Spain or Italy are bust. But a city will always be there," said the person. "Someone will always pay back the debt. They have the backing of the government and the ability to raise taxes."
A second person confirmed that buying municipal or regional bonds already being traded was one of the options being studied, also a testimony to the fact that the ECB's alternatives are limited.
Corporate debt, for example, is much sought after and therefore difficult to buy. Buying into stock markets would face opposition because of the risk. The ECB already buys covered bonds and asset backed securities.
Any move to buy municipal debt would particularly benefit the German regions that have sold hundreds of billions of euros of bonds and dominate the market, making it even cheaper for them to borrow.
But it could also help rejuvenate slack markets such as Italy or Spain although regional borrowings count in calculating a country's overall debt pile and their size is therefore also kept in check.
In the coming weeks, ECB President Mario Draghi hopes to win the backing of a majority of Governing Council, which includes national central bank chiefs, for further steps to shore up the bloc's weak economy.
Germany's Bundesbank, which is opposed to any extra money printing, may find it easier to accept the buying of municipal bonds.
Because quantitative easing is determined by the relative size of a country in the 19-member euro zone, Germany does most bond buying. Some analysts predict that it could even run out of bonds to buy, as returns dip below the ECB threshold.
Putting municipal bonds in the mix could resolve that problem.
"If the ECB wants to extend the bond purchase program, in our view, the ECB needs to include Federal states' bonds," said Hendrik Lodde of DZ Bank.
"With a lengthening of the 'shopping list', Germany can reach the level of overall bond buying intended easier."
(Additional reporting by Jon Penner in London Editing by Jeremy Gaunt)