ECB Monetary Policy after the TLTRO

The second TLTRO of the ECB, on December the 11th, has brought EUR 129.8bn of liquidity on the market. This will not be sufficient and the European monetary authorities will have to put in place new instruments, probably at the next ECB meeting on January the 22nd.

Two remarks on the ECB monetary policy
1 – The ECB has two instruments: interest rates and liquidity. The first is close to 0 at 0.05% for the refi rate. The ECB is constrained by the Zero Lower Bound. To reach a more accommodative monetary policy the ECB will have to increase liquidity to the financial and banking sector. Last November Mario Draghi took a formal commitment to increase the ECB balance sheet by EUR 1 000bn by the end of June 2016. It will then converge to the level seen in March 2012. The main reason for this liquidity is the will to rapidly curb inflation expectations
2 – In the ECB monetary policy framework, liquidity injections are temporary. It’s true for short-term operations but it is also what is seen for longer operations. Currently 2 operations that have been done, one at the end of 2011 and the other in February 2012 are reimbursed now. Their duration was 3 years. It’s an important difference with what is done by the Fed where long-term operations are purchases.

The operation of December the 11th has increased liquidity by EUR 129.8bn. With the previous operation of September the 18th which provided EUR 82.6bn the total amount is EUR 212.4bn. This is way below the EUR 400bn targeted by the European monetary authorities and announced at Draghi’s press conference on June the 5th (see here paragraph 6).
The 2 temporary operations that started in 2011 and 2012 and mentioned above are in a phase where reimbursements are important. On December the 17th banks will reimburse EUR 39.8bn. This means that the net supply of liquidity is a mere EUR 90bn (129.8 – 39.8). In September the 18th, the net supply of liquidity was just EUR 47.9bn.

The reimbursement of EUR 39.8bn is high for two reasons
The first is that there will be no reimbursement from December the 23rd to January the 14th (extreme excluded).
The second reason is related to the end of these operations. The first that started in December 2011 will be over on January the 29th. This means that, excluding December the 17th, there is only 4 dates of payment. The second that started in February 2012 will finish on February the 26th. For the first the amount that must be reimbursed by banks to the ECB is EUR 90bn; it means that on average banks will have to reimburse EUR 22.8bn at each date of payment. For the second operation the amount is EUR 154.1bn, this is EUR 19.3bn by date of payment.
If repayments are taken as the average of each operation then for the next 4 dates of payment the amount will be EUR 42bn. For the next for dates, the amount will only be circa EUR 80bn.

A simple addition/subtraction leads to the following result: From the positive amount of EUR 129.8bn we subtract the first reimbursement of EUR 39.8bn and then the amount for each date of payment. This implies that on February the 26th the amount of liquidity will be lowered by EUR -155.1bn.

Beside these temporary operations, the ECB has started the purchase of covered bonds and of ABS. The amount that has been bought is still limited yet. For covered bonds, the amount is EUR 20.9bn (at December the 5th) and for the ABS the amount is EUR 601 million.

This means that from now to the end of February the size of the ECB balance sheet will decrease. Going back to the March 2012 level as it has been announced by Draghi will be hard to manage (In September and October Draghi’s target on the balance sheet size was announced in the Q&A session only. In November, it was official and written in the introductory statement see here). If the target, in June 2016, is to be back to March 2012 level it means that the balance sheet must increase by EUR 1 000bn (with starting reference in November). As the balance sheet is currently shrinking, at least until February the 26th , the amount will be larger.

What can be done?
1 – From March 2015 to June 2016 there will be 6 new TLTRO operations. They will be based on net increase in credit. As this latter is not performing well we cannot spontaneously expect that these TLTRO operations will increase liquidity dramatically.
2 –The ECB will pursue the purchase of covered bonds and of ABS. At EUR 3bn per week (average since the beginning), the total amount that will be bought by the ECB will be EUR 245bn + the 20.9 that have already been purchased. The amount of ABS is so reduce that we don’t know what is trajectory will be.
3 – In order to satisfy to its EUR 1000bn commitment in June 2016 to reduce the risk of deflation the ECB will have to use new instruments. The purchase of corporate bonds is probably not a good idea as spreads are already limited; there is a risk of illiquidity. The only asset that can be bought on a very large-scale is sovereign debt.

I expect that the ECB will put in place a QE on sovereign debt at its next meeting on January the 22nd. It will be easier to start sooner than later as the amount to purchase will be EUR 11.6bn is the QE starts after January the 22nd and EUR 12.6bn if it starts after the March 5 meeting. (These amounts are based on the expected balance sheet profile after reimbursements. The TLTRO operations that will take place after March the 15th and covered and ABS purchases are not taken into account).

One reason to go quickly on this operation is the fact that inflation rate is 0.3% in November and could be revised down to 0.2% after French lower than expect inflation for November. The ECB wants to fight downward expectations on inflation and for that they have to go as rapidly as possible. Lower inflation expectations are also seen from the German interest rates structure. This could lead to lower resistance from the Bundesbank.

The chart shows the recent change in the German breakevenGermany-5-yearBreakeven

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