Friday, May 30, 2014

Analysts zero in on ECB's potential actions

As we approach the June ECB meeting, investors are increasingly focused on what the central bank could be contemplating (see discussion). It is clear that the ECB's focus will be credit expansion in the euro area. Along the way, Draghi and company may also want to talk down the euro. As discussed recently, the money supply growth in the Eurozone has stalled (see chart), which is the direct result of tight credit conditions. Furthermore downward pressure on prices persists, as we saw with Italy's inflation report today (see chart). Here is BofA's take on the situation:
BofA: - Laurence Boone notes the following measures could be announced to boost lending next week:
  •  LTRO conditional on lending with fixed rate & for an extended period [the ECB will provide cheap money to banks if they agree to lend it out to small and mid-sized businesses - see post]
  •  Changing the regulatory capital requirement [on banks] for holding ABS [this would be aimed at boosting consumer finance via the securitization market - see post]
The LTRO program may end up being similar to the UK's Funding for Lending Scheme.
FT: - The ECB is expected to announce a fixed-rate offer of cheap central bank funds, often referred to as a longer-term refinancing operation, according to two people familiar with the matter. Under the LTRO, banks could borrow as much as they wanted from the central bank in the form of loans with maturities of a number of years.

The ECB has used LTROs to pump €1tn into the eurozone’s financial system, though the amount offered this time could be lower as banks’ demand for central bank cash has waned. People familiar with the matter say the fixed rate will depend on banks’ commitments to support credit creation in certain areas. The LTRO is expected to ape the design of the BoE’s Funding for Lending Scheme, which allows banks to shrink their balance sheets and still benefit from the cheap loans, so long as the level of contraction is not too large.
This, according to BofA, would be accompanied by a rate cut, potentially moving deposit rates into negative territory.
FT: - Most analysts expect a cut of 10 or 15 basis points to the ECB’s main refinancing rate, now 0.25 per cent, to be matched by a cut to its deposit rate, which stands at zero. A move into negative territory in effect imposes a levy on reserves held at the ECB – a change that policy makers hope will spur lending from banks in the region’s core to those in the periphery, as well as weakening the euro.
Once again, a note of caution. If the ECB fails to deliver an easing action in the magnitude that markets expect, we are going to see some nasty volatility across global markets.
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