Draghi’s Trillion-Euro Journey Starts Today

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Mario Draghi’s trillion-euro journey is under way.

The European Central Bank will announce the result of its first targeted lending program today as part of its effort to stave off deflation in the euro area. The so-called TLTRO is among a package of measures that the ECB’s president says will boost its balance sheet to as much as 3 trillion euros ($3.9 trillion) from 2 trillion euros.

Draghi’s first step may not take him very far, with estimates for today’s offer, which is linked to the size of banks’ loans to the real economy, ranging from 100 billion euros to 300 billion euros. That’ll shift the focus to later programs including the next operation in December and still-undefined plans to buy privately owned assets, and ultimately perhaps to purchases of government bonds.

A relatively low take-up “is likely to raise further questions over the feasibility of the ECB’s goal,” said Martin Van Vliet, senior economist at ING Groep NV in Amsterdam. “While we agree that the ECB will likely struggle to meet this goal, we would suggest to wait until after the December TLTRO before drawing strong conclusions.”

The ECB will announce the allotment of funds at 11:15 a.m. in Frankfurt, with the median estimate in a Bloomberg News survey of economists showing banks will receive 150 billion euros. The four-year loans carry an annual interest rate of 0.15 percent.

Asset Purchases

Lenders may prefer to hold off until the end of the ECB’s review of their balance sheets, according to Van Vliet. The results of that check, aimed at ensuring the soundness of banks’ health, will be published next month shortly before the ECB becomes euro-area supervisor.

Banco Sabadell SA (SAB), Spain’s fifth-biggest bank, didn’t bid for funds in this month’s TLTRO and will seek to borrow 5 billion euros in December, according to a person familiar with the information.

Inflation in the 18-nation euro area was 0.4 percent in August, holding at the weakest pace since 2009 and a fraction of the ECB’s goal of just under 2 percent. Draghi has warned of a deflationary spiral of falling prices and households postponing spending.

The TLTRO program, announced in June, is intended to spur the supply of credit to the real economy to help price gains. A total of eight operations will be conducted through June 2016. The purchase programs for asset-backed securities and covered bonds were announced this month, with details to follow after the Oct. 2 meeting of the Governing Council.

Policy Divergence

Draghi’s liquidity drive highlights how the world’s biggest economies are diverging. The People’s Bank of China is injecting 500 billion yuan ($81 billion) into the nation’s largest banks to address weakening growth, according to a government official familiar with the matter. Bank of Japan Governor Haruhiko Kuroda said this month that he’ll do what’s needed to achieve his inflation (ECCPEMUY) goal.

In contrast, the U.S. Federal Reserve yesterday tapered its monthly bond buying to $15 billion in its seventh consecutive $10 billion cut, staying on course to end the program in October as the economy recovers. The Fed’s balance sheet is at $4.4 trillion. In the U.K., two of the Bank of England’s nine policy makers have called for a rise in the key interest rate.

The ECB’s liquidity additions will be reduced by the repayment of three-year loans that were offered at the end of 2011, as a credit crunch in the region loomed. Almost 350 billion euros of those loans are still outstanding and must be repaid by early next year.

‘Heavy Lifting’

The ultimate value of the TLTROs and programs to buy covered bonds and asset-backed securities will be 985 billion euros, according to the Bloomberg survey. That leaves the three stimulus measures adding a net total of about 635 billion euros.

“If the TLTRO will really move the ECB balance sheet, it will rather occur in the subsequent auctions in 2015 and 2016,” UBS AG analysts including Justin Knight said in a note on Sept. 16. “But the extent to which banks will participate in them is very uncertain. Hence we assume that some ‘heavy lifting’ in terms of ECB balance-sheet expansion will also have to come from the ABS/covered bond purchases.”

Should investors see Draghi failing to reach his liquidity goal, market borrowing costs could rise. The average cost of overnight, unsecured lending between banks in the euro area, known as Eonia, turned positive on Sept. 16 for the first time in five days. ECB Governing Council member Luc Coene said last week that officials are aiming for a negative rate.

QE Option

“We are pleased with the developments we observe on the money markets,” he said in an interview on Sept. 11. “We would expect Eonia to be slightly below zero for quite some time.”

Draghi has left open the option of large-scale sovereign-bond purchases to achieve his balance-sheet target. The policy would risk splitting the 24-member Governing Council. Germany’s Jens Weidmann has spoken out against quantitative easing and opposed the rate cuts and asset-purchase programs this month.

“If we are right about the limited uptake of TLTRO loans, then the policy will do little to stimulate bank lending,” said Jennifer McKeown, senior economist at Capital Economics Ltd. in London. “We therefore still think that the ECB will have to implement a full-blown QE program to eradicate the risk of deflation.”

 

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