TLTRO take up — a pivotal event for the euro

The second targeted long-term refinancing operation is the big event for the euro and this week. 

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Disinflation is a huge concern and with the main objective of the European Central Bank being that of price stability, Mario Draghi is beginning to run out of options.

The ECB aims to expand its balance through a combination of asset-backed security purchases and covered bonds, and it is hugely important that banks avail of this scheme.

 The programme alongside planned purchases of asset-backed securities and covered bonds has the aim of expanding the ECB’s balance sheet closer to the €3 trillion level, where it was in 2012. It’s now around €2 trillion.

The total maximum volume is around €400 billion and six more loan allotments will take place during 2016.

TLTRO is supposedly designed to incentivise banks to boost lending to the real economy. Lending has been alarmingly weak in recent years, having fallen in annual terms for over two years now and policymakers are hoping that if they provide banks with access to funds at very low interest rates for a long period of time, then, akin to the Funding for Lending scheme employed in the UK, these banks will pass it on to businesses. If a bank doesn’t increase its lending to the private sector, then it has to repay after two years.

The initial tranche which came ahead of the bank stress tests and asset quality review were a disappointment with a mere €82.6 billion taken up by the banks. Clearly some banks may have delayed participation until after the results were published and perhaps were also waiting to see details of the ECB’s covered bond and ABS purchases programme.

What is certain is that that dovish language from Mario Draghi and other central bank members has been successful in capping euro gains and this has been helped hugely by the strong rally in the US dollar. There is now a risk that the ‘long dollar trade’ is becoming crowded and this could be to the detriment of the Draghi plan. 

A poor take up, say less than €150 billion, would tend to bring the prospect of ECB quantitative easing more imminent and could very well see the euro continue in its decline. Markets will likely want to see the shortfall in the previous tranche negated by a much better take up at this juncture so it’s likely that unless we see a stellar figure that the bias for the euro will be southwards. We could expect to see the recent lows of $1.2250 breached and this would put the euro on a trajectory towards the $1.20 level – last seen in July 2012.

Anything over above the €230 billion mark could allow the ECB more breathing space and delay the prospect of sovereign debt-buying which could well see the euro retake the $1.25 level and possibly beyond.

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