Bad News for ECB Loans May Be Good News for QE-Seekers

Bad news for the European Central Bank may be good news for investors eager for it to start quantitative easing.

The ECB will tomorrow issue a second round of long-term loans to banks as part of a plan to spur credit and boost inflation. A repeat of the lackluster demand seen in the first round could signal that the central bank now has little choice but to step up its unconventional stimulus to include buying government debt.

The less banks borrow from the ECB, the more policy makers must find other ways to meet their stated intention of injecting as much as 1 trillion euros ($1.24 trillion) into the financial system. A flop tomorrow could therefore boost bonds and equities by implying a greater chance of the U.S.-style QE that President Mario Draghi has said may come early next year.

“We doubt this week’s targeted longer-term refinancing operation, and the program in general, will stand in the way of the ECB moving to sovereign QE in early 2015, although this week’s take-up may help influence the likely timing of such an announcement,” said Nick Matthews, senior European economist at Nomura International Plc in London. “Our view remains that the ECB’s intention to expand the balance sheet is not achievable via its existing measures.”

More Control

The median estimate in a Bloomberg News survey is for a take-up of 148 billion euros, with a range from 90 billion euros to 250 billion euros. The first round in September raised less than 83 billion euros.

Against that, 270 billion euros in long-term loans issued by the ECB in late 2011 and early 2012 come due over the next two months. Banks could use the TLTRO cash simply to repay the older loans, with no net boost to the central bank’s balance sheet.

Draghi acknowledged the challenge and the need to be more proactive last week when he said the ECB is “getting more control” of its balance sheet with its newly started programs to buy covered bonds and asset-backed securities.

An unconventional trade in which bad news was good news for investors was a feature of U.S. markets last year, when they were trying to judge how long the Federal Reserve would keep buying assets.

In July, August and September 2013, nonfarm payrolls reports were all weaker than economists predicted, yet the Standard & Poor’s 500 Index rose after each release. The worse the data, the more likely the Fed would keep buying, so the theory went.

Now all eyes are on the ECB for what Scott Thiel of BlackRock Inc. calls “one of the most important” events for the euro area in the remainder of 2014. If the ECB is pushed toward QE, equity investors may cheer.

“More realistic monetary policy -- more reflective of fundamentals -- is rewarded,” said Thiel, head of the global bond team at BlackRock’s Investment Institute.

Before it's here, it's on the Bloomberg Terminal.