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Guest Commentary: A Glimmer of Hope for Europe and the Euro

Guest Commentary: A Glimmer of Hope for Europe and the Euro

Jonathan Granby, Analyst,,

The three-year loans offered by the ECB to banks have helped stabilise the euro zone. The European Central Bank said on December 8th that it would offer unlimited funds for 36 months at its main interest rate, at two auctions. The first auction, on December 21st, attracted bids of €489 billion. This was more than the amount lent under its previous lending mechanism in 2009 of one-year loans. This second round of providing liquidity to the market has had similar effects to the first round; overnight interest rates have dropped and longer-term bond yields for investment-grade euro region countries have fallen too.

The drop in short-term rates looked like a relative certainty at the time but the drop in longer-term bond yields however, was less of a sure thing. While on paper borrowing money from the ECB for three years at 1% looks like an obvious carry trade, it appeared that only the most desperate or most daring banks would be interested in loading up on Spanish and Italian debt. Especially during a period when banks were being warned to raise capital against declines in the value of those very bonds. Despite these apparent concerns ten-year Italian bond yields have dropped and Spanish yields have followed suit. It would appear that the ECB has succeeded in stopping the rot and capped bond yields in peripheral countries. The headline number of €489 billion accompanied by the promise of a second three-year auction later this month has turned sentiment around.

However, a whole host of concerns remain. Banks are working to meet new capital ratios set by the European Banking Authority (EBA) by June 30th, since capital is hard to come by loans to consumers and businesses are likely to remain scarce. This coincides with the ECB saying in its quarterly bank-lending survey that credit conditions had tightened substantially. Additionally, data for December shows that loans to the private sector and bank deposits both fell sharply. All of which point to a lingering recession in the euro area.

There are also concerns with the ECB playing such a large role on the balance sheets of banks. For periphery nations the issue of ‘addiction’ to ECB funding to finance current account deficits must be taken seriously. While across the continent as banks pledge more collateral to the ECB in return for funds the attractiveness of the banks’ own bonds falls as investors get pushed back in the queue in the case of bankruptcy.

It remains too early to suggest that the worst of the European debt crisis is behind us by there is comfort to the fact that the ECB has managed to stabilise the region. The decline in bond yields, both short and longer term, give the ECB the opportunity to focus on reinvigorating growth in the region; the most important component to putting this whole mess behind them.

Written by Jonathan Granby, Analyst,

Jonathan Granby is an analyst for where he provides coverage of G10 FX.

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