How Big Will the ECB’s Next Liquidity Injection Be?
The European Central Bank’s second injection of long-term liquidity into markets could reach as much as 1 trillion euros ($1.33 trillion), analysts predict.
Initial estimates for the February 29 operation of three-year, long-term refinancing operations (LTROs) suggested that there would be only about a 100 billion euros take-up by Europe’s banks, but those estimates have shot up in recent weeks after the success of December’s operation became clear.
December’s action by the ECB has spurred a stock market rally after increasing the supply of cheap money, and ECB Director-General Francesco Papadia even suggested that the bank could say “mission accomplished” after the operation.
Yet the effects on the real economy are still to be seen. Banks have shored up their balance sheets, but lending figures to consumers and businesses remain low.
“The hope is that it will trickle down,” said Christel Aranda-Hassel, director of European economics for Credit Suisse, who believes there will be a take-up of around 500 billion euros at the second auction.
“Bank lending is not just a supply issue – the demand side is not looking too happy either, and you can’t do much about demand as a central bank. If you’re fiscally constraining a series of countries to comply with targets, then you’re stuck.”
While the headline figure of 489 billion euros made December’s three-year operation the biggest single refinancing operation ever undertaken by the ECB, this was slightly misleading, some analysts argue. Banks also slashed their use of the existing Main Refinancing operation and of the shorter, 3-month LTROs, making the net increase in outstanding ECB open market operations only around 210 billion euros.
“What we get in terms of ‘new money’ will be much bigger than in December,” Aranda-Hassel said. She estimates that around 350 billion euros of February's sum will actually be a net increase in the amount of ECB open-market operations.
There are also concerns about what can be used as collateral for the loans and whether the ECB could lower the quality of collateral. The ECB’s governing committee may outline further plans for the second round after meeting Thursday.
“We have seen this movement in Japan and in the Bank of England, the Federal Reserve. We will see it in the ECB. Hopefully we won’t go too far for too long. I hope we avoid the mistakes that others have made,” Norbert Walter, the former chief economist of Deutsche Bank and managing director of Walter & Daughters, told CNBC.
“The one big question that’s still outstanding is how to win collateral,” Aranda-Hassel said.
Firm guidelines were promised in December, and the key point is expected to be whether loans to small and medium enterprises can be used as collateral. There are concerns that if exposure to these loans becomes Europe-wide, they could potentially be more damaging if they are not repaid.
The question of what banks will do with this money if they are not lending it to businesses and consumers lingers, with some concerns that the money could create bubbles in other asset classes if banks use it to play the market.
“This liquidity, as long as it only helps to prop up balance sheets of banks and doesn’t go into any other asset classes, shouldn’t create another bubble. The central bank could absorb this liquidity from the banks at any moment if needed,” Walter said. “In Germany, people are already beginning to move into asset classes like real estate or gold again, and we may see small bubbles in those asset classes already.”
Walter believes that there will be further, similar LTROs in the future, although not any new instruments.
“I’m very happy that within the ECB, everybody is really deeply concerned to find the best and fastest way to get out of this damn trap,” he said.