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Opinion

ECB talks tough on LTRO3

Assumption is that central bank liquidity will keep on coming.

Recent pronouncements by high-ranking European Central Bank officials have been at pains to dampen expectations of further cheap liquidity from the central bank.

Speaking at the recent International Capital Market Association AGM in Milan, Peter Praet, member of the executive board of the ECB, struck a note of caution.

"You have to find the right balance when you provide liquidity – in our case particularly to the banking sector," he warned. "We want to smooth the process but not to slow down initiatives for reform. All we hear from the banks is, ‘Give us more time, give us more time.’

"The idea [behind liquidity provision] is to smooth the unavoidable deleveraging of the banking system and to avoid fire sales but at the same time we have to operate a very delicate balancing act."

The impression that the liquidity taps have been firmly turned off was underscored by further comments from Francesco Papadia, adviser to the ECB and its former director general of market operations. Speaking in a personal capacity, he said of the two long-term refinancing operation (LTRO) auctions that have taken place: "I am tempted to say ‘mission accomplished’. This problem has been dealt with in an effective way."

This might be the official line emanating from the central bank, but it is in stark contrast to the understanding on which much of the bank funding market is now operating. Several investors that spoke to this magazine last month were unequivocal in their belief that the ECB might be talking tough but it will be forced to keep funds flowing regardless.

The ECB has not been providing support on anything like the scale of the other central banks: actual and announced asset purchases as a percentage of GDP by the ECB stand at around 3% in comparison to the Fed’s 17% and the Bank of England’s 22%. There is therefore widespread belief that further LTRO auctions are on the way, particularly if there is any suggestion of another eurozone bank coming under stress.

The assumption is that the ECB will keep pumping liquidity into the system as long as it takes –and if that means LTRO 3, 4, 5 or 6, then so be it.

As the stimulus from the second auction fades into a distant memory and the bank funding markets again start to seize up, the next few months will reveal if they are right.

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