Spanish yields and the ECB's austerity defence

Now we come to what happened at last week's ECB announcement and presser. Most of the subsequent commentary focused on the main refinancing rate cut, the hint of a negative deposit rate, and the commitment to spur lending to small- and medium-sized companies.

But our pal Lorcan Roche Kelly of TrendMacro emphasised something different in his latest note:

  • Most critically, in his speech at the press conference, ECB President Mario Draghi also gave the longest forward commitment yet to the continuation of weekly fixed-rate full-allotment refinancing operations by the ECB: they will now continue until July 2014. As forward guidance goes, this is a pale shadow of the Fed's policies, but it is a major step for the ECB.
  • This move is not exactly another long-term refinancing operation (LTRO). Rather, it is a long-term commitment by the ECB to provide limitless liquidity every week, on a short-term basis.
  • It is roughly analogous to a 15-month LTRO that banks can access on a weekly basis.
  • It renders meaningless much of the free option given by the 3-year LTROs. The two 3-year LTRO operations only extend for five and seven months, respectively, beyond the new commitment from the ECB.
  • This may well lead to increased early repayments of the current outstanding 3-year LTROs. For banks the upside to remaining in the operations has been largely removed today.As the terms are fixed until July 2014 at the earliest, banks can now be assured of funding when they need it in the short to medium term, without being forced to access it immediately -- as happened in the 3-year LTROs.

Draghi's recent comments are being mainly interpreted as a double-down on austerity. That's not wrong and it remains unfortunate, but there are several complicating factors that are nonetheless worth remembering.

One is simply that Draghi probably needs to keep reiterating the importance of budget constraints for internal political reasons (giving himself cover at the Bundesbank).

Another is that Draghi has long been more concerned with structural changes in labour markets and economies than in broad-based austerity for its own sake, as Lorcan notes. Draghi is generally against tax hikes, for instance, and would prefer spending cuts. Of course, this particular nuance isn't exactly comforting given the brutal choices faced by the countries on the periphery.

Monday, May 6, 2013
Financial Times