Are the euro's gains just starting as the ECB balance sheet shrinks further from LTRO repayment?
278 European banks have repaid €137 billion ($184 billion U.S.) in the first LTRO operation, which raised €489 billion ($658 billion U.S.) in December 2012. LTRO-2 from February 2012 now receive a repayment of about €250 billion ($336 billion U.S.).On today's announcement, the Spanish 10-year yield saw its biggest decline of all eurozone bonds, losing 15 bps versus a mere 3 bps for its Italian counterpart. This is partly explained by the fact that Spanish banks were the biggest borrowers in LTRO-1 lending, accounting for 41% of total take-up, compared to 25% from Italian banks.
Repayments of LTRO-2 will be announced on February 22 and will take place on Feb 27. As European banks repay about €400 bn, the immediate analysis to make is to expect a reduction in liquidity and a run-up eurozone overnight interest rates - something the ECB has worked hard to avoid. But EU banks will continue to seek funding from the ECB's shorter-term LTROs, keeping their needs sufficiently met.
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Regardless of whether LTRO repayments will keep €200 billion or €500 billion in excess liquidity in the eurozone monetary system, the ECB is the only major central bank not to have issued a fresh dosage of asset purchases as is the case of the Fed, BoJ and inevitably the BoE (following its triple quarterly growth dip). The above charts show the ECB balance sheet has in fact shrank by 5% over the last six months compared to increases of 5-15% for the other big three.
The ECB's refraining from currency wars may not be the only reason for the euro's sharp rebound. 32-month highs in Germany's business surveys and solid auctions by most periphery eurozone nations as of late can be categorized among “stabilizing fundamentals” for the eurozone. The road to $1.37 in EUR/USD remains intact as suggested in our Dec 4 note “1.35 Euro Target Revised Up." $1.40 is no longer deemed an aggressive forecast, and is considered baseline objective for early Q2 2013.