When QE Backfires: ECB Purchases Raised Safe-Bond Yields by 30bp

The mechanism is straightforward. When a central bank buys risky bonds using its own reserves, it removes risky assets from private portfolios and replaces them with the risk-free reserves. The total stock of safe assets in the economy rises. Investors who previously held safe government bonds for their safety properties find that their need for that safety is now partially met by the new reserve supply. They demand less of a premium to hold government bonds. That higher yield on safe bonds partially offsets the yield decline the central bank intended with its purchases.

The study focused on four AAA-rated countries: Germany, Denmark, Sweden, and Switzerland. Germany had the highest safety premium at 124 basis points, followed by Switzerland at 70, Sweden at 54, and Denmark at 16. The ECB's purchases included both safe core bonds and risky peripheral bonds. Because the central bank paid for all of them with reserves, the net effect was to expand the safe-asset supply.

For bond investors, the finding carries a caution. The impact of QE on safe yields is not a simple mechanical relation. The composition of the purchases matters. When a central bank buys risky assets, it may inadvertently raise yields on the safest bonds by reducing their scarcity premium. The authors say the findings apply globally, given integrated financial markets.

The ECB's bond holdings peaked at about 37% of euro-area nominal GDP in 2022. The paper appears in the Journal of International Economics.