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Nordea: Monetary policy already tightening in the Euro zone

November 13, 2012
While the ECB has continued to introduce new measures to make its monetary policy more accommodative, in some respects policy has actually become tighter, and may continue to do so going forward. More specifically, the excess liquidity in the Euro-zone banking system has fallen quite clearly already from its highs.

The amount borrowed from the ECB’s refinancing operations reached a high of more than EUR 1300bn last summer, but has since fallen to around 1150bn. The change in total borrowing from the Eurosystem has been smaller, however, as Greek banks have increased their reliance on the so called Emergency Liquidity Assistance (ELA). Still, if one looks at the measure of excess liquidity – measured by the usage of the ECB’s deposit facility and excess reserves of Euro-zone banks – there has still been a decline, albeit only around EUR 40bn.

The drop in the usage of the ECB’s operations reflects some genuine improvement in market conditions. This is illustrated by the fact that e.g. both Spanish and Italian banks have been able to scale back their borrowing from the ECB, albeit very marginally, especially for Italy.

Going forward, the usage of the ECB’s liquidity facilities will likely continue to fall. The 3-year operations that form the bulk of all the refinancing operations, with some EUR 1020bn outstanding, can be paid back early at any time (weekly repayments) after around one year. For the first 1-year operation, the first date for early repayment will be 30 January 2013.

At least one bigger bank has indicated that it intends pay back its 3-year loans from the ECB during the first quarter of next year. It definitely makes sense to use the flexibility offered by the ECB in terms of paying back the 3-year loans to avoid a huge amount of operations expiring at the same time.

However, no huge interest for paying back the loans after as early as one year looks likely. The cost of 0.75% for 2-year funding still looks a very low price to pay, while many banks still have few alternatives. After all, the bulk of the 3-year funding went to the countries struggling amidst the debt crisis. In addition, as the repayments can be made at any time (weekly) after the first repayment date, the optionality to make an early repayment later remains.

As a result then, the early repayments of the 3-year ECB refinancing operations are unlikely to change the picture of excess liquidity materially. Even if we saw EUR 100 – 200bn of repayments, the immediate effect on the shortest money market rates would likely be very limited, as more than EUR 500bn of excess liquidity remained even in that case.

That said, we could very well see an upward creep in some of the longer money market rates in anticipation of the repayments. Any such moves could be used for positions receiving slightly higher rates, as the remaining liquidity would keep the shortest rates close to zero, or even negative in some cases. In short then, money market rates are not about to move notably higher any time soon. 

Usage of the ECB’s refinancing operations fallen from highs















Also excess liquidity decreased slightly but remains huge