First some charts from Barclays:
The chart on the right shows the declining level of excess liquidity in the euro area as LTRO payments continue to bite. Barclays’ forecast puts the breach of the ‘psychological level’ of €200bn, below which Eonia may start to be sensitive to changes in liquidity conditions, in Q3/Q4 if the pace of weekly repayments remains at around €6bn (the average weekly payback, excluding the two big repayments on the first day of the exit option window for each operation). That isn’t something many people were predicting at the start of the year.
Their rational:
So far a total of €252.8bn (including €8bn that will be repaid on Wednesday 10 April) out of almost €1trn of the 3y liquidity borrowed at the two operations has been repaid. As a consequence, the liquidity surplus has declined to about €370bn. As shown in Figure 2, the paybacks have come mainly from banks in core countries, while peripheral banks have reimbursed only a small part of their total borrowings. However, it is likely that peripheral banks will start to repay before maturity to plan a gradual exit from the two operations (this holds true for Italian banks, which have not reimbursed anything yet, but it is unlikely that they will repay the entire amount of their 3y borrowing, €255bn, on the day of the natural maturity of the two operations).
It’s obviously unknown if repayments will continue apace in the second half of 2013 but the chance of that €200bn mark being breached is worth flagging. Excess liquidity is how the ECB goes about lowering its rates and historical analysis suggests that Eonia starts moving higher as excess liquidity falls below €200bn.
While it is true that the ECB is at pains to stress its ongoing “accomodative” nature — meaning it will satisify demand for liquidity via shorter term operations — it may feel compelled to act if that level comes into view.
What it can do isn’t clear. It’s obviously constrained and it’s unlikely we will get anything radical. Barc suggest a few of the more realistic options (compared to large scale asset purchases, a Funding for Lending equivalent and the like):
First, [the ECB] could reduce further the reserve requirement (close to zero, as in the context of a liquidity surplus, the importance of the reserve requirement as a monetary policy instrument is much lower). However, depending on the pace of the weekly repayment, this change would only affect the liquidity surplus by about €100bn, not enough to counterbalance the paybacks and bring the surplus into a comfort zone, ie, well above €200bn. Second, and more likely, the ECB could conduct another LTRO: while it may be used to roll maturing 3y LTROs for a number of banks (thus not increasing the surplus), it may be done such that it pushes the surplus higher again, if the ECB makes the terms attractive enough (pricing, maturity and/or collateral). Our preferred option would be for the ECB to conduct 3-5y LTROs, unlimited in amount, on specific SME-type collateral, and possibly at fixed (rather than variable) rates. We would expect such an announcement in the summer.
However, considering the demand-led nature of the ECB’s balance sheet, the fact that simply paying back LTRO cash isn’t necessarily a bad thing and that Eonia’s movement upwards is likely to be limited for a while at least — JP Morgan’s model suggests that it will fix below 10bp if excess liquidity exceeds €120bn, given the current level of the refi (75bp) and deposit rates (0bp) — there is surely a chance of Draghi sitting tight… at least where this problem is concerned.
Related links:
The great European bank heist reversal – FT Alphaville
Draghi’s pro-LSAPs? FT Alphaville
LTRO repayment bifurcation risk – FT Alphaville