ECB: drastic cut in growth estimates and TLTROs

The meeting this past 7 March of the European Central Bank produced a new road map decided with unanimous approval. Given the weakening of the macroeconomic situation and the consequent reduction of the growth and inflation estimates for the three years 2019-2021, the European Central Bank decided to postpone any interest rate hike at least until 2020 and to launch a new round of long-term financing for banks with two-year duration starting from September 2019 up to March 2021. The interest rate on loans in Targeted Longer-Term Refinancing Operations will be linked to the MRO (Main Refinancing Operation) rate which is currently zero.

This new round of TLTROs is a stage subsequent to the previous non-conventional policy actions of the European Central Bank. In January 2015 QE aimed at the purchase of European government securities had the explicit objective of squeezing the entire matrix of risk premiums and the implicit ambition of weakening the Euro to relaunch the lame European economy through the “foreign channel”. The second stage of the non-conventional policy launched in March 2016 was aimed more at the lending side of the entire economy through the launch of TLTROs and the purchase of corporate bonds. This latest round of financing is instead designed to tackle the funding of European banks: banks which had borrowed the first tranches of the first cycle of TLTROs from June 2019 would have had to start refinancing their repayment. The Italian banks alone from June 2019 would have had to refinance approximately € 240 billion in an interval of a year and a half.

The risk, if the European Central Bank had not launched this new round of TLTROs, was a freezing of bank funding with adverse consequences on the real economy, owing to a probable contraction of loans to consumers and businesses. Then obviously there remains the problem of a European economy where the real problem is not so much the offer of credit, but rather demand, owing to the structural weakness and uncertainty of the macroeconomic situation.

The effect of TLTROs on the financial markets has already been seen after the announcement: interest rates on European government securities down sharply (10-year German bund now close to zero) with the related curves flattening considerably. The Italian BTP was also the clear direct beneficiary of the new measures decided by the European Central Bank: many Italian banks will have an incentive to resume carry-trade operations.

The world of lending in the medium term is an indirect beneficiary of the TLTRO measures: the compression to levels close to zero of the risk-free rate entails a race towards all bond instruments that have an additional return.

Finally, while on the one hand the TLTRO solves the funding problem of banks that would have had more difficulty (in particular therefore peripheral and second-tier banks), the profitability of the European banking equity sector is further handicapped by interest rates, which will remain at levels close to zero with the slope of curves almost flat for several quarters more. The equity market certainly did not celebrate this indication and the European banking sector immediately after the announcement was down almost -4%.

Comment by Andrea Ponti, Portfolio Manager of the Fixed Income Team.