Monday, November 29, 1999

Jumbo loan payback to put ECB exit on back burner

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The July 1 deadline for banks to repay the European Central Bank nearly half a trillion euros will start a chain reaction likely to force the ECB to put its exit strategy on hold and keep lending lifelines in place into 2011.Banks have to pay back the 442 billion euros they borrowed at the first of the ECB's three one-year cash injections last year.It is over half of the 850 billion euros currently being borrowed from the ECB and been the principle driver behind the record-low level that interbank rates were at until the debt crisis broke out. .Wiping out such a huge amount of cash from the system in one hit would normally have major ramifications. However, the ECB has padded the date with extra borrowing opportunities that it hopes will avoid any inappropriate spikes in money market rates.Three-month loans will be available the day before and a special 6-day operation has been scheduled for July 1 which will overlap with the ECB's next offering of weekly loans."At least half of the 442 billion is going to be rolled (reborrowed)," said one money market desk head, who expects little reaction in overnight money markets ."The result is that there will still be a lot of liquidity in the market. I'm convinced there will still be enough (excess liquidity) to not have Eonia going to up to 40-50 levels."Others are not so sure. Analysts at Citi point out that the 1 percent cost of the relevant 3-month operation is well above market rates and therefore unappealing, a big difference to last year's mouth watering one-year offering."Most of the expiring 442 billion euros of the first 12 month operation - which was very attractive with a rate of 1.0 percent compared to 12 month Euribor of almost 1.6 percent when it was introduced - is unlikely to be replaced.""Consequently, liquidity should drop substantially after 1 July, leading to a quick increase in overnight rates and upside pressure on other short-term money market rates."POSTPONED PROBLEMSCalculations based on ECB data show the level of liquidity in the euro zone banking system is close to a record high.(for graph of euro zone liquidity click normal circumstances that would suggest low demand but the situation is likely to be shaped by the euro zone debt crisis, which has left banks from the most indebted countries almost entirely reliant on ECB liquidity.Spain's treasury secretary Carlos Ocana admitted this week some Spanish banks were being shut out of interbank markets saying it was: "definitely a problem."Bank of Spain data also showed that Spanish banks borrowed a record 105.6 billion euros from the ECB in May, 16.5 percent of the total lent by the ECB.Analysts at Bank of America Merril Lynch expect banks to reborrow 260 billion euros of the expiring 442 billion next month.That would leave over 100 billion euros of surplus cash in the system, but they warn that a liquidity crunch is likely to hit banks later in the year."The 3-month tender that banks will likely use to rollover the 1-year expiry will mature on 30 September, the same day as the expiry of the second 1-year tender (75 bln eur) and the March 6-month tender (18 bln eur)," they wrote in a note."Banks would be rolling both 1-year tenders and the 6-month one into the 3-month tender that settles on the same day. A similar situation will happen on 23 December when both the 3-month in September and the final 1-year tenders expire."That would see things come to a head at the same time banks have to navigate the notoriously tricky year-end period."December 23 would be an important day with year-end just around the corner and a significant portion of the (combined) 614 billion euros in 1-year tenders currently outstanding needing to be rolled over on that day."EXIT HOPES ON HOLDMost economists agree that with problems likely to persist for some time, the ECB will be forced to extend its support, the most important element of which is its promise to lend banks as much money as they want until at least mid-October.Bank of American Merrill Lynch analysts see it keeping the unlimited loans flowing into next year while Citi also expects to see support measures extended."The ECB will either tolerate (or envisage) an increase in overnight rates back to the policy rate or it will have to introduce additional measures to keep money market rates around current levels," analysts said."With the uncertain outlook on the economy and the fragile financial market situation, we expect the ECB to opt for the latter option."One option ECB policymakers appear to have ruled out for now is another one-year loan. The fear is perhaps that it would make raising interest rates early next year -- when most economist currently expect -- an awkward job.There is no sign of more six-month loans either. It means banks' funding vision will continue to shorten until October when expiring 6 and 12-month loans reach the point where they have 3-months left to run. Banks can then tap normal 3-month ECB lending operations."The shorter the duration of the debt profile the higher the risk," said Lloyds economist Kenneth Broux. "What if the rate situation changes are institutions well positioned to react?""I think the ECB is going to be in this for some time yet."(Reporting by Marc Jones; Editing by Toby Chopra)
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