5th March 2012
The take-up for the second part of the LTRO was ahead of that in December, which came in at €489bn. It also widened its scope with 800 banks taking part. Not all banks revealed the extent of their use of the mechanism, but even the apparently strongest groups, such as HSBC, participated.
The first round of LTRO was widely credited with creating sufficient confidence for the re-embracing of risk assets that has taken place since the beginning of the year. Ahead of the latest round, it was thought that it might have a similar impact. However, as this FT Alphaville piece points out, any monetary easing programme is subject to the law of diminishing returns.
As it was, the post-LTRO rally quickly lost momentum: "[Investors] are working out at what stage they should hand over from this relief rally to company fundamentals," said Jon Peace, European banks analyst at Nomura. "The fundamentals are challenging and the earnings season for the banks hasn't been great."
The markets now need some reassurance that the LTRO is having a wider impact. The initial rally reflected the fact that one systemic risk factor had been removed and a collapse of a European bank looked less likely. As Simon Ward, chief economist at Henderson, suggests: "It's been effective in stabilising the banking system but it's unclear whether it will provide a significant boost to the money supply and, by extension, economic growth. The January money numbers this week showed a faster contraction in real M1 deposits in the periphery, implying still-worsening economic prospects."
"Caxton FX said in a note that "on the one hand, the large take-up suggests that liquidity will continue to improve and that euro-zone institutions will be more robust moving forward. However, some might take it as a clear indication of ongoing instability…What is important now is that European banks use these funds to lend to individuals and businesses to stimulate economic growth, rather than just buying up government bonds."" In other words, markets want clear indications that the LTRO is acting to boost growth rather than simply prevent a banking collapse.
It may well be that in protecting the banking sector, the LTRO is encouraging further deleveraging, which may – perversely – weaken economic growth further. A combination of weaker bank lending and austerity could be toxic for many of the peripheral European countries.
In this summary of the views from Wall Street, David Thebault, head of quantitative sales trading at Global Equities says: "Now the focus will turn to the ECB's overnight deposit facility. If the number falls, it means the money is being put at work. I'm staying 'long' euro zone equities, although I'll start buying put spreads soon to get protection against a possible short-term pull-back."
The first job of the LTRO was to stabilise confidence in the banking system. In this policymakers can take a bow – systemic risk has certainly diminished. However, it now needs to show more value for money to impress markets once again.
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