Lombard Odier warns about implications of Europe’s banks repaying the ECB

8th February 2013

Lombard Odier’s investment strategy team have warned that moves by the Eurozone banks to start repaying loans extended by the European Central Bank will lead to tightening credit conditions.

Although repaying the loans offered under the Longer Term Refinancing Operation may be seen by many commentators as a return to some sort of normality, the move comes as many Eurozone economies are flagging. There are fears that the repayments could disrupt the supply of credit to small businesses at just the wrong time. It also reduces the balance sheet of the ECB, which will mean more upward pressure on the value of the euro just when other developed economies are devaluing. This presents another headache for Europe’s businesses.

Lombard Odier’s note makes two main points.

·         Repayments go hand in hand with a shrinking of Eurozone banks’ balance sheets. In turn this means that credit to the private sector is contracting. This process has much further to run, implying that tight credit conditions are here to stay.

·         A key consequence of the repayment of LTRO loans by Eurozone financial institutions is the reduction of the ECB balance sheet, at a time when its US and Japanese counterparts are doing just the reverse. This is putting upward pressure on the Euro – obviously not a welcome development for Eurozone economic growth in general, and for German exporters in particular.

Investment strategy team members Stephanie Kretz and Karen Guinand add: “While we ultimately expect the ECB to re-join the QE trend, the immediate contraction of liquidity in Europe, combined with investor complacency bordering on euphoria, and a number of red flags in the US  leads us to re-emphasize the importance of protecting downside risks in portfolios.”

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