Spending a trillion euros could prove tricky for ECB

By Marius Zaharia

LONDON (Reuters) - Hoarders of euro zone debt could frustrate the European Central Bank's plans to buy a trillion euros of mostly government bonds over the next 18 months, starting on Monday, to revive the bloc's economy.

Seeking to soothe concerns the central bank might struggle to meet its 60 billion euros a month spending target, ECB President Mario Draghi argued last week that sellers would be found among foreign investors that hold about half the region's debt.

Overseas investors should be the most willing to sell as printing euros is likely to weaken the single currency, reducing the value of their holdings in their own currencies.

But, aware of the problems the ECB faces in finding domestic sellers, some see an advantage in holding onto their bonds. Their reluctance to sell could mean the scheme risks distorting segments of the sovereign borrowing markets.

Robin Marshall, director of fixed income at investment firm Smith & Williamson in London, says he is "in no hurry" to sell.

"Why would you sell if you are aware of these difficulties with domestic sellers? The prospects of squeezing more gain out of it will make you more reluctant to sell also.

"I'm not sure he's got this right," Marshall said, referring to Draghi.

With official interest rates forecast to rise in the United States and Britain in the next 12 months, overseas investors may also be wary of switching into those markets just as yields start to rise and bond prices to weaken.

Such hesitance could force the ECB to pay above-market prices for the bonds and push yields significantly lower, leading to market distortions.

Investors from within the euro zone who are holding onto their paper include banks, which use short-dated bonds as a liquidity buffer because these are the only assets for which regulators do not require cash to be set aside as a precaution. Pension funds and insurers may choose to retain their long-dated bonds because regulators push them to hold assets that match their liabilities.

The ECB and national central banks of euro zone countries, together known as the Eurosystem, began buying bonds on Monday to start the long-awaited quantitative easing scheme.

Barclays strategists estimate the ECB's programme will include 850 billion euros of government bonds, compared with net debt issuance by national treasuries of 290 billion euros this year. The Eurosystem is also buying smaller amounts of corporate debt, including asset backed securities and covered bonds.

"IT'S ALL A PUZZLE"

Hedge funds and other asset managers, especially those based abroad will naturally be more willing to sell. But they know they can drive a hard bargain.

Foreigners might hold half of the market but that is unlikely to be true for each individual bond, some of which may be mostly in the hands of euro zone-based investors.

The ECB could not immediately provide a geographical breakdown of euro zone bondholders.

As long as that uncertainty persists, the ECB will have to be very convincing in its bids for bonds.

"Different bonds have different sellers. It's always a puzzle. I don't think anybody has a clear clue on who exactly is going to be selling," said Marchel Alexandrovich, European economist at Jefferies.

"It's all guesswork ... and the ECB is in that situation as well. They might have to pay up."

For instance, it is likely to be harder for the ECB to buy Italian and Spanish bonds than German and French paper.

Around two thirds of Italian and Spanish debt is held by domestic investors. The rest is held by non-residents, though that may include banks or pension funds based in the euro zone.

More than 60 percent of German and French debt is held by non-residents.

"If we start with this very high share of domestic holdings for Italian and Spanish debt it means that these debts should be more resilient than German and French debt," said Cyril Regnat, fixed income strategist at Natixis.

The ECB's decision not to buy bonds yielding less than its minus 0.2 percent deposit rate might make it easier to convince investors to sell. But it does not fully eliminate the complexity of the task.

The ECB could face a major headache if it finds it harder to buy one particular bond compared with another from the same country but with a shorter maturity.

If the ECB needs to make that purchase to meet the target, its bid might temporarily push the yield on the longer-dated bond below the shorter-dated one -- an anomaly which could be exploited by investors looking for arbitrage opportunities.

"You are going to get weird dislocations in the market," Rabobank rate strategist Lyn Graham-Taylor said.

"I think it's a question of 'we'll see how it goes'. What more can they do? You can't plan everything."

(Editing by Catherine Evans)