Viewpoint: ECB on hold until the next 36 months auction.

The February ECB meeting may once again prove interlocutory……


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While signals supporting a cut of the refi rate below 1.0% in March cannot be uled out, such action seems unlikely to us, also considering that the “preliminary signs of conomic activity stabilising at low levels” have been partly confirmed; the balance of risks has hanged significantly, and could improve further with the February auction. Any action will be ushed back to after 28 February. The 36-month auction could meet with still high demand for unds, aiding a further drop in short-term rates.

Ask and you shall receive. The February ECB meeting may once again prove interlocutory. We oubt the ECB will take important action before assessing the outcome of the 36-month uction on 28 February. Expectations for a takeover of funds almost as high as at the ecember repo. Early this week the Financial Times speculated that the amount auctioned ould even be twice that placed in December. On the one side, European banks are likely to ontinue accumulating funds at favourable rates to face their refinancing needs beyond 2012.
Also, as the new rules on collateral come into force the pool of banks accessing to the auction ay widen. In addition, the encouragement from the ECB will mitigate reputational issue and oster participation. Last but not least, the demand for funds might be fuelled again by the arry trade opportunity on the short end of the government bond curve. On the other hand, n its January bulletin the ECB (pages 30–31) noted that refinancing needs were the main eterminant of the demand for funds by the 523 banks that took part in the December repo.

Yet, the EUR 489Bn allocated in December might already cover around 80% of the bank aturing debt since, according to an ECB study from last November, the European banks’ ebt maturing in 2012 is in the order of EUR 350Bn and an additional EUR 225Bn come due n 2013, mostly consisting of old medium-term paper (3-4 years). Therefore, we consider it nlikely that financing needs may play a more significant role than they did last December; lso, the sharp drop in short-term yields that has already taken place may have cooled the enthusiastic pursuit of carry trades.

The expansion of reserves that the next 36-month repo could potentially generate will be automatically transferred to the deposit facility. Open market operations mechanically increase outstanding base money, and are therefore reflected at the aggregate level either by an increase in bank current accounts (not remunerated) or in stronger recourse to the deposit facility (remunerated at a 0.25% rate). However, this does not mean that liquidity does not flow within the system, because, as underlined by ECB President Draghi at the January’s press conference, the banks that make strong recourse to the deposit facility are not the same that borrow from the ECB. Notably, the banks of peripheral countries borrow extensively from the ECB, but the deposit facility is mostly used by Northern European banks. For an exhaustive explanation of this topic, see the dedicated section at page 4 of this issue of WEM.

In its January bulletin the ECB noted that the massive expansion of liquidity recorded in December lead to an immediate increase in base money. However, it is neither automatic nor taken for granted that the increase in base money is reflected by the wider M3 aggregate, as was already case, for instance, in the aftermath of the first 12-month repo held in June 2009. In its October 2011 bulletin, the ECB remarked that the failure to create a propagation effect in 2009 was due to a decline in the M3 multiplier, and in particular to an increase in the reserve/deposits ratio. Therefore, an the increase in base money did not trigger the portaolio allocation process that would have been expected based on the approach tied to base money multipliers, as it was associated with higher demand for reserves from the system. It is highly likely that we are again witnessing the same phenomenon observed in 2009; but it may also be that with the second 36-month operation the perception of risk improves further and prompts, albeit at a slow pace, a recovery of interbank lending. The 3-year operations announced by the ECB have undoubtedly reduced the risk of a credit crunch due to the lack of financing at non-prohibitive costs. The ECB’s latest Bank Lending Survey shows a clear worsening of credit conditions at the end of 2011 and in the opening months of 2012. The survey was carried out between 19 December 2011 and 9 January 2012, and therefore is affected in part by the three-year auction launched in December. The survey highlights an improvement in access to the market, but in a still hostile context for many credit institutions. If the balance of risks benefits further from the auction effects, the ECB could leave rates unchanged 1.0% also in March. In the past month, confidence surveys confirmed the “preliminary signs of economic activity stabilizing at low levels” mentioned in the ECB press conference at the beginning of January. Data are still compatible with a stagnation, or a mild recession, of the European economy in 2012. In December the ECB was still relatively optimistic, as it estimated average growth in the euro area at 0.6% this year. In March the central ECB growth estimates may be brought down closer to zero, as opposed to broadly unchanged inflation estimates. A lowering of growth estimates would justify a refi rate cut to 0.75%, but this should not be taken for granted. The balance of risks has changed significantly, not only for banks, but also indirectly for the economy. If the improvement in the trend is confirmed, households and enterprises may start to exercise less caution in making spending decisions.


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