Good News for Europe Behind the Headlines
Analyst: David Kelland
Greece's 10-year notes hit a 2-year high yield of 11.90% this week, as German Chancellor Angela Merkel played down anticipation of an imminent deal.
All news was not bad for the Eurozone, however. The most well-known part of the ECB's asset-purchase program is the public sector purchase program (PSPP), through which national central banks in the Eurozone (not the ECB), purchase 60 billion euro per month of European government and agency debt. This program is very familiar to financial market participants because it involves direct intervention in markets by central banks and people like to know with whom they are trading.
There is also a lesser-known program called the Targeted Longer-Term Refinancing Operations (TLTRO), which began disbursing 4-year loans to banks in September of 2014. This Thursday, the take-up at the auction exceeded expectations, as 143 banks borrowed 97.8 billion euro from the ECB at a cost of 0.25%. Presumably, banks would not borrow money from the ECB unless they intended to lend it to businesses and consumers (particularly when they would have to buy 15-year German debt just to earn a yield above 0.25%)
Whether or not the ECB's unconventional monetary policies get transmitted to the real economy and cause more economic activity is an important question. In the Continental financial system, banks play a much greater role in providing financing to companies than in the Anglo-Saxon financial system, like that of the United States. Historically, European banks (as opposed to the corporate bond market) have provided about 80% of financing to businesses.
One risk now, as was the case in Japan after the Heisei bubble popped in 1989, is that the Eurozone has zombie banks that will not expand their balance sheets (borrowing more and lending more), even with money that is almost free because they are already overextended. There is also the risk that consumers and businesses do not want to borrow until they see the economy accelerate, in what game theorists call a coordination problem. The strong up-take of TLTRO funding suggests that either these problems are not such big problems, or the bankers have very poor judgment regarding their own banks situations and the behavior of their customers.
Frederik Ducrozet at Credit Agricole said in reaction to the TLTRO take-up data, "TLTRO should provide a self-reinforcing stimulus while revealing banks' own expectations of future lending flows. In all, we view today's number as excellent news for Eurozone domestic demand prospects."
In the end, ECB stimulus will only work if the money can get through the banking system to businesses and consumers. The behavior of banks in seeking TLTRO funding suggests that they have customers who want to borrow and that the banks themselves are willing to lend.