ECB Liquidity-Boost Urgency Seen Fading Even on Cash DropJeff Black and Kristian Siedenburg
The need for a new injection of cash into the euro area’s banking system may be fading as stress in the region eases.
Of 19 economists surveyed by Bloomberg News, 11 said there’s no requirement for another long-term refinancing operation from the Frankfurt-based central bank, even after excess cash in the region’s financial system fell to the lowest level since December 2011. Five economists said new loans will be needed this year, while three said they’ll be wanted in 2014.
Euro-area banks are repaying three-year loans made at the height of the sovereign debt crisis. While that’s draining cash, ECB President Mario Draghi has backtracked from an earlier signal that excess liquidity should stay above 200 billion euros ($271 billion). Instead, the ECB has pledged since July to keep interest rates at or below current levels for an “extended period,” helping to keep the cost of bank funding down.
“This is a sign that things are slowly beginning to go back to normal,” said Marchel Alexandrovich, an economist at Jefferies International Ltd. in London. “It’s a very different environment than the end of 2011. For the ECB, this is a neat outcome; they are exiting from their extraordinary measures without having to actually formally tighten policy.”
The ECB provided banks with more than a trillion euros in 3-year loans in late 2011 and early 2012 as a credit crunch threatened, with the option to repay them early. Lenders have since paid back nearly two-thirds of the original net increase in funding, in part because the ECB’s OMT bond-buying plan in September 2012 helped calm fears that the euro area would break apart.
Excess liquidity was at 212 billion euros as of yesterday, ECB data shows. Draghi said on Sept. 5 that the lower threshold “depends on the context; it depends on the degree of fragmentation that we have.”
His pledge that the ECB’s benchmark rate will stay at the current 0.5 percent or lower for an extended period has so far had some success in keeping short-term market rates in check. Eonia, the rate that banks pay to lend to each other overnight, remains stable and anchored just above the ECB’s deposit rate of zero. Expectations of future borrowing costs, as measured by Eonia forward contracts, have fallen to about 0.22 percent from 0.33 percent in June.
“We have been exiting quietly and smoothly from an extraordinary phase of high central bank liquidity provision,” ECB Vice President Vitor Constancio said in Frankfurt on Sept. 26. “But if declining excess liquidity were to put undue upward pressure on short-term rates, we would have to address this problem.”
Global rates surged after June 19, when the U.S. Federal Reserve said it was considering reducing its bond purchases as the nation’s economy recovers. European rates rates climbed to levels that that Draghi dubbed “unwarranted” in August.
“The ECB may want to be on the safe side given the non-linearities between excess reserves and EONIA, said Annamaria Grimaldi, an economist at Intesa Sanpaolo SpA in Milan. Even so, ‘‘there’s no urgency right now’’ for a further LTRO, she said.
The euro area still faces further potential market disruptions, including an ECB review of bank balance sheets, due at the beginning of 2014, that may reveal capital shortfalls.
The ECB can afford to wait a little longer before that review, according to Frederik Ducrozet, an economist at Credit Agricole CIB in Paris who says an LTRO is unlikely until December. The central bank could boost its forward guidance by putting a definite end date for loans at a particular cost, by issuing an LTRO with a fixed rate, he said. The previous loans were charged at the average of the ECB benchmark over the maturity.
‘‘A properly-designed LTRO would have the potential to kill several birds with one stone by enhancing forward guidance, keeping excess liquidity higher for longer, and further boosting the use of collateral from small businesses,’’ Ducrozet said.
ECB officials including Executive Board member Benoit Coeure have played down the short-term likelihood of a new round of long-term loans, saying that while it remained an option, it hasn’t been specifically discussed. The ECB’s Governing Council convenes in Paris on Oct. 2 for its monthly rate-setting meeting.
The central bank’s members ‘‘have recently made clear that further liquidity would be injected in the system if needed and we expect the same message to be reiterated next week,” said Annalisa Piazza, an economist at Newedge Strategy in London. “That said, the current reduction in liquidity has not affected EONIA rates yet, and the ECB has pointed out that part of the early repayments reflect better conditions for euro-area banks.”