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Until next time

28 February 2012 By Neil Unmack

The ECB’s second three-year liquidity facility should attract enough takers to avoid a spookily-low outcome. But those expecting a massive splurge will likely be disappointed. And the prospect of further long-dated funds looks remote, for now.

The take-up at Wednesday’s three-year long-term refinancing operation, or LTRO, needs to avoid the extremes. Too low, it would signal that banks are deleveraging too quickly, which would be bad for growth. Too high, it could raise concerns over how the banks will exit the funds three years from now.

There are several reasons to expect the second LTRO to roughly match the first one from last December. Italian and Spanish banks stepped-up their national government bond purchases in January, suggesting a willingness to put on carry trades; looser collateral rules could allow smaller banks to borrow more; and banks located outside the euro area, notably British lenders, are reported to be planning to tap ECB funds.

The latest Reuters poll of money-market traders suggests a take-up of about 500 billion euros, in line with the December operation. That would be enough to avoid serious disappointment; Societe Generale reckons a take-up of less than 400 billion euros would be bad for risk assets. Still, even 500 billion euros might disappoint the bulls. A survey by the Royal Bank of Scotland shows that 86 percent of investors expect 500 billion or more, and 59 percent more than 600 billion euros.

Markets can probably cope with some mild disappointment. The bigger question is what happens next. According to RBS, three-quarters of investors expect the ECB to follow suit with more long-dated LTROs. They may have to wait. For one, the ECB will want to see whether the first three-year facilities actually help the real economy. It could take up to nine months for looser lending terms to translate into credit origination, according to Deustche Bank. Second, the ECB is reluctant to keep giving banks free funds, which distort markets and leave euro zone central banks exposed to the peripheral economies whose banks are heavy users of the LTRO.

Lastly, more cheap money is no longer needed to avert a bank crisis – as it was in December – and it could take the pressure off governments just when they’re being asked to reform and boost euro zone bailout funds. Markets may have to wait for a deeper crisis before they see more ECB largesse.


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