EURUSD: Why TLTRO disappointment open the door to further weakness
News that Europe’s banks had taken up EUR 130 bn of the ECB’s Targeted Long-Term Loans (TLTRO) was greeted with a whimper by the FX market. EURUSD managed to bounce off the lows of the day so far at 1.2414; however it is struggling to break above 1.2440 as we write this copy. In our view, the latest auction from the ECB is a disappointment and is bearish for the EUR in the long-term as it keeps the door to QE open.
ECB largesse is coming…
The ECB had hoped that its TLTRO programme would, eventually, boost lending and credit growth in the region. Credit growth to the private sector has been negative since mid-2012, and the ECB believe that if this can be reversed then it will spur growth in the future. However, after two rounds of TLTRO auctions, Europe’s banks have taken EUR 210 bn worth of funds in total. Considering Mario Draghi has said that he wants to boost the ECB’s balance sheet by EUR 1 trillion, he is still some way off, and may need to take further radical measures to reach this goal. Added to this, banks are also expected to repay some EUR 200 bn of LTRO funds, the first round of the ECB’s long-term lending facility that was started in 2011, by the end of this year which could shrink the ECB’s balance sheet further.
Money on Draghi’s mind
Overall, QE is still a real possibility after this auction, and the market is pricing in the prospect of bond purchases from the ECB. German 30-year bond yields have fallen below 1.5% for the first time, and Euribor rates remain 0.08%. The reasons why the TLTRO programme may be under-performing include: 1, demand for loans from consumers remains low as businesses and consumers go through a painful de-leveraging process; and 2, banks are still conservative in their lending practices, even after the ECB’s stress tests were released earlier this year. One could argue that QE won’t alleviate these problems, so why bother with it? Some members of the ECB council could be thinking the same.
Are negative deposit rates the answer?
If lending is not the answer to the ECB’s problems then the most powerful weapon the ECB has available is a weaker EUR. While we doubt that the ECB will embark on a BOJ-style attack on its currency, the best way for it to weaken the currency, boost inflation and potentially spur lending is by cutting deposit rates further into negative territory, say to -2— -3%. This is something the SNB in Switzerland is thinking of doing, and it could work for their euro-area neighbours. The next ECB meeting on 22nd Jan is an early highlight of 2015. Will they do QE or cut deposit rates further into negative territory? Either way, the next policy steps from the ECB are likely to be EUR negative, and could trigger a move back below 1.20.
While the EUR is at risk from ECB largesse, it could benefit stocks as we move through to the end of the year. However, if deposit rates are cut deeper into negative territory then this could weigh on the banking sector, as it costs them to park any funds they don’t lend with the ECB.
Takeaway:
- The latest TLTRO auction has been a disappointment.
- It looks like Draghi won’t be able to boost the ECB’s balance sheet by EUR 1 trillion with its TLTRO programme alone.
- This opens the door to more radical action like QE…
- However, it doesn’t look like lending will boost the Eurozone economy at this stage, as demand for loans seems to be weak.
- This leaves a weaker EUR as the most potent weapon left for the ECB
- Aside from QE, cutting deposit rates deeper into negative territory could be the most effective way to weaken the single currency.
- Whatever the ECB decides to do, the EUR may remain vulnerable.
