ECB to wind down covered bond purchase programme - sources

By Marc Jones and Aimee Donnellan

LONDON, Oct 8 (Reuters) - The European Central Bank will end its second covered bond purchase programme at the start of November as planned, euro zone monetary sources say, despite having spent less than half the money set aside for it.

The ECB introduced the 40 billion euro programme last November but the overwhelming sense of fear created by the euro zone's debt crisis meant it had little of the positive impact the original round of purchases had back in 2009-10.

It was also overtaken in importance by the trillion euros of ultra-cheap funding, or LTROs, the ECB injected into the banking system in December and February and made issuing covered bonds expensive in comparison.

Covered bonds are those guaranteed by other assets, often real estate.

"We realised that the (covered bond) market wasn't as bad as we had thought and that in fact, for various reasons, the issuance wasn't actually there," one euro zone central banker said on the condition of anonymity.

"There was the maximum time limit that was originally set and it was decided that if it (40 billion euro spending limit) wasn't reached by that date then so be it... It is prudent not to spend the money if it is not needed."

The ECB declined to comment but a second euro zone central bank source confirmed the programme would be left to expire.

Policymakers and the bank's experts also know that covered bond and other bank funding markets are closely linked to sovereign bond prices, something its new Outright Monetary Transactions (sovereign bond buying) programme is targeted at.

NEUTRAL IMPACT

It will be the first time the ECB has not completed one of its purchase programmes but the decision is unlikely to come as a major surprise.

With covered bond issuance dropping off in the wake of the LTROs, the ECB has had to compete with private investors for allocations.

To date, only 16.3 billion euros of the programme's 40 billion euros has been spent and purchases have been creeping along at a snail's pace in recent weeks.

"I think if the programme were to wind down it would be credit neutral for the market," said Ralf Grossmann, head of covered bond origination at Societe Generale.

"There has been very little primary supply in Spain and Italy which has given central banks few opportunities to assist the banks they set about helping."

Some covered bond specialists also argue that there have been some unintended negative side effects from the programme.

"It has helped certain issuers throughout the past 11 months but it also had the unintended consequence of damaging liquidity in the secondary market," said Richard Kemmish, head of covered bond origination at Credit Suisse.

"Traders are much less willing to go short on bonds knowing that the ECB might start to buy them."

One of the central bankers told Reuters that it was hard to say whether the programme would be revived at a later date.

Analysts aren't pinning their hopes on it. "I don't see any negative impact from just letting it finish," said one banker who spoke on the condition of anonymity.

"It's nice to have a backstop bid in the market but with so many investors struggling to find paper and issuers in the periphery selling their bonds to private investors it doesn't seem all that necessary."

(Reporting by Marc Jones and Aimee Donnellan. Editing by Jeremy Gaunt.)

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Keywords: ECB/COVEREDBONDS