The latest in our series of risk-event previews looks at the 2nd operation of the ECB’s Targeted Longer-Term Refinancing Operations (TLTROs), the results of which will be released Thursday 11 Dec @ 10.15 GMT
When first proposed on June 5th the ECB stated that the LTRO’s would be:
- aimed at improving bank lending to the euro area non-financial private sector, excluding loans to households for house purchase, over a window of two years
- to intensify preparatory work related to outright purchases of asset-backed securities (ABS).
At the December meeting of the ECB Draghi made it clear that their wait and see approach would be taking a keen interest in the 2nd tender after a disappointing but expected low take-up of just EUR 82.6bln previously in September, which, net of the 3year LTRO repayment and the roll from the main refinancing operation (MRO), resulted in a net liquidity injection of €48bn.
Draghi denied rumours that there would be a change to the way in which the TLTROs would be conducted/issued to make them more attractive/easier for borrowers this time around and prior to that meeting ECB chief economist Peter Praet had said he was confident they will hit the EUR 1 trillion balance sheet expansion but warned that the ECB will analyse the situation if TLTRO take-up is too low.
Among the measures already implemented (TLTROs, covered bond and ABS purchase programmes), the TLTRO is expected to provide the most sizable contribution to the ECB balance sheet expansion. Therefore, this second operation is an important test of the capacity of the current measures to get the intended €1trn balance sheet increase to which Praet referred.
So the pressure is on and expectations are greater, but the jury is still out
The first operation saw a low uptake of just EUR 83bln and another low uptake could put some upside pressure on EUR front-end rates. However,low demand at the TLTROwould also increase the chances of an increase in asset purchases early next year, which would be viewed as EUR-negative.
Conversely, a large draw at the operation could reduce QE hopes, squeezing EUR shorts even if it kept EUR front-end rates heavy
One trigger for more easing from the ECB would be that the current measures are not enough to boost the balance sheet, and so far the ECB still expects the balance sheet to move towards its early 2012 dimensions.
However, after the take-up of the December TLTRO, the ECB should start to realise more is needed to boost the balance sheet towards EUR 3trln, as the TLTRO is the measure with the largest potential to increase the balance sheet.
The December TLTRO is an important test of the capacity of the current measures to get the intended €1 trillion balance sheet increase
Draghi -Watching and waiting
Although some additional banks are likely to take part in the December operation, given the timing now is arguably better than in September due to the AQR/stress test results having been published, there is also a risk that banks could adopt a cautious approach due to the increasing economic uncertainties.
One reason could simply be that these cheap loans are not all that cheap in real terms. For now, it is still cheaper for lenders to rely on the ECB’s regular refinancing operations, where they can fund themselves at record low rates of 0.05%. They will be obligated to pay an additional 10 basis points for the new four-year loans.
Another reason is the fact that banks in the Eurozone don’t actually need additional liquidity. Demand for credit is waning amidst uncertain recovery and awful levels of unemployment, while lenders are increasingly cautious about borrowers.This issue underlines criticism by many economists in that the ECB is actually addressing the wrong problem . It’s not the supply side of the credit which needs attention, but the weak demand. Does one automatically benefit/enable the other?
And the ECB’s decision to impose a tax of 0.2% on excess deposits held at the central bank (the negative depo rate) has also curbed lenders’ appetite for holding excessive amounts of liquidity. But that argument also misses the point that the TLTRO money is designed to make its way into the economy, not be hoarded or used to shore up bank capital ratio requirements.
So in conclusion we can say that a take-up in excess of €200-250bln would help get to the €400 bln total that Draghi first hoped for from the two tenders and would buy him and the ECB some more time. The euro should stage a further relief rally if so.
A similar take up to that in September, however, or even an amount between €150-180 bln would increase the chances of a green light for QE at the ECB’s Jan 22 meeting even if Draghi will certainly not be having it all his own way. Cue another euro slide to test the depth of support down here.