The reduced activity of the European Central Bank in the Eurozone government bond market, following the cessation of reinvestment under the APP quantitative easing programme; it was quickly covered by other buyersmaking its transition to a credit tightening regime smooth and trouble-free.

According to an analysis by the ECB, entitled: “Who is buying bonds now? How markets reacted to the reduction of the Eurosystem’s balance sheet”, the ECB’s footprint in the Eurozone bond market is returning to 2020 levels, when it had launched its massive Pandemic Emergency Program (PEPP) bond purchases.

As of mid-2022, the central bank’s balance sheet has been reduced by about $2 trillion. euros or more than 22%, mainly due to the repayment of loans with zero or negative interest that the banks had received but also the non-reinvestment of capital from bond maturities.

In 2020, the total amount of outstanding Eurozone government bonds amounted to almost 8 trillion. euros, while the purchases by the ECB and the value of the government securities that the banks had given as collateral to receive the loans on favorable terms exceeded 3.5 trillion. euros and corresponded to 31.5% of the market.

This figure rose to close to 40% in mid-2022, but has since started to decline and is approaching 2020 levels again, despite record bond issuance from Eurozone countries.

But how did the market adjust and which investors filled the gap left by the ECB’s policy change by absorbing the rising issuance of government bonds? The figures show that it was foreign investors and Eurozone households that contributed mainly in this direction.

Foreign investors have traditionally been the biggest buyers of Eurozone government bonds, with a share reaching 40% before the ECB began bond purchases in 2015. Their holdings then halved, only to rebound with higher purchases when the central bank’s reinvestment under the APP stopped. The return of foreign investors, mainly investment funds and hedge funds, is explained by the increase in bond yields following the tightening of the ECB’s monetary policy from mid-2022 with its successive interest rate hikes.

The increased contribution of foreign investors was also particularly evident in the issuance of a Greek 10-year bond at the end of January, amounting to 4 billion euros, when demand reached a record high of 35 billion euros. Of course, the fact that four rating agencies recognized by the ECB – S&P, Fitch, DBRS and Scope – gave the Greek economy an investment grade in the second half of 2023 contributed to this development.

Today, the percentage of purchases of Eurozone government bonds by foreign investors is close to 30%, which is lower than it was a decade ago.

Also noteworthy is the return of households to the bond markets, which were the biggest buyers after foreign investors in 2023, with the percentage they hold in the market increasing to 3.5%, close to the pre-2015 level. The increased bond yields, combined with the special issues made by Eurozone countries and the slow and limited increase in deposit rates by banks, made government bonds attractive to households.