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Wednesday June 30, 2010 - 19:23:24 GMT
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Funding Pressures on European Banks and ECB (FXA)

There is no question that the modest “rollover” today in ECB 3-month fixed rate (1.00%) LTRO was a clear sign that funding pressures in the European banking system are not as dire as many assumed heading into the news of today’s allotment.  With EUR442bln in 12-month LTRO maturing (bid by 1121 banks) only EUR132bln was taken today for Thursday settlement (by just 171 banks).  Banks appear to be not nearly as panic- struck for cash as price action in financials this week suggested (less so in the credit market metrics).   


Adding to a better sense of bank funding availability was news (today I think – not on Refi calendar) today from Trichet that the ECB would conduct a 6-day MRO (main refinancing operation) Thursday which will make more Bank funding available to banking system now that longer-term concerns on financing appear to have abated some and banks can turn to more short-term (still ECB) funding.  This is also another sign of a new leaf at the ECB (first was the 180 on bond purchases in May) – an uncharacteristic flexibility.   Necessity is the mother of invention.  One should expect similar unscheduled MRO’s ahead as more LTRO’s come due.  And if market conditions remain tight and interbank lending in lockdown I would not rule out a resurrection of the 6-month LTRO at an upcoming ECB General Council meeting (though unlikely next Thursday after today’s “success”).


Nonetheless, I think there are still signs that bank funding remains a problem for some banks despite the much smaller than expected “rollover” today.  First of all one needs to ask oneself what kind of collateral are banks posting with the ECB for funds…dregs of the dregs…why keep weak collateral on balance sheet and give ECB the good stuff.  Think of Greek bonds for a minute – yes despite rating cuts the ECB still accepts it as collateral but with larger haircuts…an expense for banks.  So part of the low rollover today may be explained by less favorable terms for collateral that goes back to the banks for reserves Thursday.   And we should look more closely at number of banks and allotment at Thursday’s 6-day MRO to see where demand for funds really is now. 


I also could not help but notice the Greek central bank today reported that ECB funding to Greek banks hit a record EUR89bln at the end of May up from around EUR50bln at the end of 2009…I tend to think Greek banks are not getting much from the interbank market in terms of funding.   And I also doubt Spanish banks are getting much access to interbank lending. 


And before we get too congratulatory on ECB policy flexibility, there is still a remarkable amount of denial – rather than walking refinance rate down to the interbank lending rate, the ECB is offering funds at a relatively punitive rate compared with market rates and has created a magnetic pull for market rates…marching toward the refi rate...3-month Euribor hit a 9 ½-month high today at 0.767% at the fixing.  If not for the slide in the EUR monetary conditions would be tightening at a time when the ECB should be engineering easier conditions.  So the ECB is only partly transformed or turning Fed-like in addressing the crisis.  And with the ECB’s unrepentant endorsement of fiscal adjustment across the EZ there appears to be absent any sense of offsetting actions from the monetary side of the policy equation. 


Europe appears to be heading toward deflation and could drag the rest of the developed world with it…and if decoupling is still as unimaginable in the global (interlinked) economy as it was in 2009 not even the relatively robust developing economies will be insulated from a heavy dose of developed world deflation.  And it may well turn out as Krugman argued in Monday’s NYT op-ed the result of policy mistakes and not some exogenous inevitability.


David Gilmore  


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