Inside the ECB’s Feckless ‘Stimulus’

The ECB is stimulating! Or at least that is how it and the media are portraying President Mario Draghi’s recent decision to renew the central bank’s “targeted long-term refinancing operations” (TLTROs). Media have speculated for weeks this would happen, describing it as a “major policy reversal” and a “U-turn.” We think this gives the ECB too much credit. Thursday’s announcement largely extends the status quo—an unnecessary move, in our view. While couched as stimulus, we think it was really designed to defang a false fear: maturing TLTRO loans.

First, understand: TLTROs are not quantitative easing (QE). Under QE, the ECB bought long-term bonds to reduce longer-term interest rates. By doing so while fixing short rates just below zero, they reduced the difference between short- and long-term interest rates. Because banks borrow short term to fund long-term loans, this reduces profits on future lending. By contrast, TLTROs let banks borrow funds for a fixed period directly from the ECB at discounted rates, providing they use them to underpin loans to businesses and consumers.

This isn’t the first time the ECB tried extending cheap funding to banks. TLTROs’ predecessor was 2011’s longer-term refinancing operation (LTRO), sans the first T, which didn’t require banks to lend the funds. Amid a debt crisis and recession, banks scrambling for liquidity took out over €1 trillion in three-year LTRO funds. When LTRO repayment approached in 2014, the ECB introduced the first TLTRO with four-year maturities, allowing banks to roll over their LTRO funds if they put them to work. Banks took €430 billion. In 2016, rather than wait four years, the ECB launched TLTRO-II—another four-year facility—which permitted greater borrowing at lower rates for new private sector loans. Banks not only rolled over most of their TLTRO-I funding, but they increased it to €739 billion. Repayments for TLTRO-II are now poised to start coming due in the next 12 – 18 months. The ECB’s announcement it will offer two-year funding should allow banks to roll over funding once again.

Since last year, folks have raised concerns over TLTRO-II’s wind down—thinking “financing cliffs for banks” await—but TLTROs aren’t really necessary anymore, in our view. Many fear banks repaying the ECB will lack sufficient funding to extend loans, sapping eurozone loan growth. But we think this is a stretch. Banks are, for the most part, amply funded in Europe. TLTRO funding may be marginally cheaper than deposits, interbank borrowing or tapping the ECB’s permanent (shorter-term) lending facilities, but it isn’t as if banks are at a loss for funding new loans. Moreover, banks have already repaid €284 billion of their TLTRO-II loans early, and overall eurozone lending hasn’t suffered. Hence, we think the ECB’s move targets a false fear.

The ECB’s TLTRO-III announcement last Thursday—with quarterly auctions starting September—doesn’t hurt, but it isn’t hugely stimulative, either. If the ECB hadn’t re-upped TLTROs, we doubt markets would have rippled much. As it stands, it just extends the status quo a couple more years, helping some banks with tighter deposit funding roll over previous TLTRO-II loans. But most large eurozone banks have no such issues. Meanwhile, credit is circulating fine in the eurozone, supporting private sector growth.

Markets’ initial negative reaction to the ECB’s move seems inspired, in part, by some worrying Draghi & Co. see weakness ahead. But central bankers have no unique insights into the economy. You need look little further than the Fed’s decision to force Lehman Brothers to fail in 2008, the wrongheaded global QE craze and central banks’ actions worsening the Great Depression. Ironically, the same day the ECB announced TLTRO-III, revised eurozone Q4 GDP data showed the slowdown was driven by inventory adjustment—more evidence weakness is likely a one-off. Nevertheless, the ECB lowered its 2019 eurozone GDP growth forecast to 1.1% from 1.7% a few months ago. Perhaps that holds up, perhaps not. But we are skeptical.

The economic outlook remains bright. The eurozone’s yield curve is positively sloped, incentivizing steady private sector loan growth, regardless of TLTROs. Plus, the latest purchasing managers’ indexes (PMIs) and PMI new orders indicate Q4 weakness was likely temporary. The eurozone’s composite PMI—combining manufacturing and services—rose to 51.9 in February, led by the services sector, GDP’s biggest driver. While PMIs indicate only growth’s breadth, not its magnitude, levels above 50 signal expansion. Moreover, services new orders also indicated broadening growth—which should keep chugging along in 2019. That so many take a dim view despite the evidence suggests weakness is overstated. Forward-looking markets move most on the gap between reality and expectations. Dour expectations provide a low hurdle for reality to clear. As reality dawns, revealing people’s worst fears unwarranted, markets should rally.