One view regarding the unexpectedly poor showing at Wednesday’s last ever six-month Long-term refinancing operation (LTRO) by the ECB is that there’s too much liquidity in the eurozone.
Barclays Capital’s Laurent Fransolet emphasizes the point in his take on the financing operation. As he stated on the day (our emphasis):
The low number can be explained by 1) the fact that the market rate for the same maturity was much lower than the bidding rate (also compared to previous LTRO), 2) the fact that there is already a large surplus, so most banks do not need extra money as such, and 3) the ECB probably pushed banks not to bid aggressively (by having an indexation mechanism, and maybe exercising some moral suasion).
Today’s small number does not change much the liquidity conditions in the euro area: there is still a very large surplus, of more than 200bn, way more than enough to keep EONIA low for the coming 3 months.
Here, meanwhile, is a pictorial view of just how much excess liquidity is currently stalking the system, also from Fransolet (who also points out that the recent rise will be down to banks’ liquidity needs decreasing, rather than the liquidity provided increasing):
And for those wondering how that liquidity surplus might be affected by the maturity of previous operations and the expiry of programmes further down the line, BarCap’s Euro Weekly note from last week offers the following chart reflecting exactly that :
According to the above, therefore, a critical point might lie in June. That’s when the €442bn borrowed by banks in the 2009 1-year LTRO comes up for refinancing.
After that, though, it’s not clear at all whether euro-system liquidity will remain as abundant. As Fransolet wrote on Wednesday:
While 1 week and 1 month operations will remain at full allotment (until at least October), this does not guarantee that there will be a liquidity surplus anymore: it will very much depend on the appetite of banks to borrow from the ECB at such shorter maturities. On balance, we think EONIA will remain low probably until October, but we would not bet aggressively on this: EONIA market rates for July/Sep could rally further, but post October rates look already quite low to us, not discounting any normalisation until Q1 2010 at least.
There are two points to be stressed with regards to that. One, as Barclays Capital points out, is the fact that banks will find it impossible to refinance the total €442bn at the ECB – especially since the three-month LTRO will be limited to €100bn by then.
In fact, some €150bn probably won’t be rolled over at all, say the analysts.
The second point is how the Euro Overnight Index Average (Eonia rate) might react.
In all likelihood the benchmark rate will remain low until at least October, say the analysts, as banks will still have unlimited access to the ECB’s weekly and one-month operations.
Nevertheless, the degree to which they do will depend “on banks’ appetite to borrow from the ECB at 1 per cent for much shorter maturities”, BarCap argues.
One thing is sure: the relationship between the liquidity surplus and Eonia will not be as predictable as before.
Which might turn out to be a big thing if you consider just how stable the rate has been since the ECB started its liquidity operations last June:
As for those monthly spikes, Fransolet explains they correspond with reserve maintenance periods at the ECB, when the central bank comes into the market to mop up liquidity.
The surplus at those times thus becomes smaller or negative, which has the effect of pushing Eonia higher. The spikes do not therefore reflect volatility in the rate.
Related links:
What does weak demand for ECB funds mean? – FT Alphaville
So farewell, 12-month LTRO – FT Alphaville
The ECB as liquidity monster – FT Alphaville
RIP Eonia – FT Alphaville
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