Why Draghi’s Cheap Cash Offer to Banks May Lack Appeal

Photographer: Martin Leissl/Bloomberg

European Central Bank President Mario Draghi acknowledged the slowdown of growth momentum earlier this month and said the trend reinforces the need for structural reforms, especially as “heightened” geopolitical risks “may have the potential to affect economic conditions negatively.” Close

European Central Bank President Mario Draghi acknowledged the slowdown of growth... Read More

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Photographer: Martin Leissl/Bloomberg

European Central Bank President Mario Draghi acknowledged the slowdown of growth momentum earlier this month and said the trend reinforces the need for structural reforms, especially as “heightened” geopolitical risks “may have the potential to affect economic conditions negatively.”

Mario Draghi’s promise of cheap cash for banks betting on the euro-area revival is losing its allure.

Economists in the Bloomberg Monthly Survey cut their estimate of the take-up of funds under a program designed to boost bank lending. The reduction signals concern that the outlook for the currency bloc may be too weak to drive demand for loans, undermining a policy the European Central Bank president says is key to restoring the region’s health.

An escalating standoff with Russia threatens to worsen the prospects for the 18-nation euro area, where growth has already ground to a halt and inflation is running at the weakest pace in almost five years. That’s increasing pressure on the ECB to step up stimulus with radical tools such as quantitative easing to avert the risk of deflation and renewed recession.

“The next step is to see how big the demand is for liquidity,” said Peter Dixon, an analyst at Commerzbank AG in London. “If it falls well short of expectations then that’s the point at which the ECB may need to think again and start to bring the QE debate back to the table.”

The Trouble With Falling Prices

Analysts estimate that banks will borrow 650 billion euros ($870 billion) in the targeted longer-term refinancing operations, or TLTROs. That’s down from 710 billion euros estimated in last month’s survey.

The euro was down 0.3 percent today and traded at $1.3363 at 5 p.m. Frankfurt time.

‘Very Attractive’

Draghi said in July that the maximum size of the program could be about 1 trillion euros. On Aug. 7, he said market estimates and indications by individual banks point to a take-up of between 450 billion euros and 850 billion euros.

Lenders can apply for funds from the ECB at 10 basis points above the benchmark interest rate, which was cut to a record-low 0.15 percent in June. Initial offers in September and December will be linked to the existing level of banks’ loans to the real economy, and subsequent operations will be dependent on financial institutions increasing those loan books.

Economists in the Bloomberg survey see appetite waning for the later operations. They forecast banks will take 293 billion euros, down from 350 billion euros predicted last month.

Draghi said this month that the TLTROs are “very, very attractive” and will lead to a “significant expansion in credit.” The program was announced in June as part of a wider package, including a negative deposit rate for the first time, aimed at returning inflation to just under 2 percent. Consumer prices climbed 0.4 percent in the year to July, the weakest pace since October 2009.

Riskier Outlook

Economists are less optimistic than a month ago about the outlook for the euro area. More than a quarter of respondents said conditions will deteriorate in the next four weeks, compared with 10 percent in July. Almost half identified inadequate structural reforms as the biggest risk, with 39 percent citing the Ukraine crisis.

Data last week showed the euro-area recovery unexpectedly halted in the second quarter as the region’s three biggest economies failed to grow. Germany’s gross domestic product fell more than forecast and France stagnated for a second straight quarter. Italy succumbed to its third recession since 2008.

“I’m convinced that more can be done and I’m also convinced that the ECB is getting ready to do more,” Italian Finance Minister Pier Carlo Padoan said in an interview with BBC Radio broadcast yesterday. “Quantitative easing has worked well in the United States, but of course the underlying economic structure of the U.S. economy is largely different from the still-fragmented euro area.”

Structural Reforms

The Bundesbank said today that geopolitical tensions may impede a rebound of the German economy. “Expectations for a strengthening of economic momentum in the second half of 2014 underlying the spring projections are called into question by current data,” it said in its monthly report.

Draghi has called for countries to implement structural reforms, saying that nations that have done so are recovering faster. Spain’s economy expanded last quarter at its quickest pace since 2007, and Greek GDP fell at its slowest pace in almost six years.

Even so, the ECB president said that “heightened” geopolitical risks “may have the potential to affect economic conditions negatively.” The EU, together with the U.S., has rolled out sanctions against individuals and companies in Russia’s $2 trillion economy because of President Vladimir Putin’s support of separatists in Ukraine. Russia banned a range of food imports from those regions in response.

Recession, Deflation

Concern that the standoff will turn into a trade war has hit investor confidence. A gauge of expectations for the euro area published this month by the ZEW Center for European Economic Research fell the most in three years. The Stoxx Europe 600 index has dropped about 5 percent since early June. Yields on German and French 10-year bonds slid to record lows in anticipation of more ECB stimulus.

“In the short term, an escalation of the Russia-Ukraine conflict may be the biggest threat -- it could lead the euro zone back into recession, possibly triggering deflation,” said Kristian Toedtmann, senior economist at Dekabank in Frankfurt. “In the longer term, structural reforms are of utmost importance. A lack of reforms would mean that high unemployment becomes structural and the economies of the peripheral countries still don’t have an adequate capability to adapt to a changing environment.”

To contact the reporters on this story: Alessandro Speciale in Frankfurt at aspeciale@bloomberg.net; Jana Randow in Frankfurt at jrandow@bloomberg.net; Joshua Robinson in London at jrobinson37@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Paul Gordon, Zoe Schneeweiss

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