What rate cut? Euro zone banks raise even as ECB eases

FILE PHOTO: The logo of the European Central Bank (ECB) is pictured outside its headquarters in Frankfurt, Germany, April 26, 2018. REUTERS/Kai Pfaffenbach September 23, 2019
By Francesco Canepa
FRANKFURT (Reuters) – Euro zone banks have raised, not cut, the rates at which they lend to each other since the European Central Bank cut its own rates earlier this month, which negates part of the ECB’s stimulus effort.
The increase in some key inter-bank lending rates, while small, may force the ECB to rethink some components of its stimulus package to ensure households and companies don’t end up footing the bill, bankers warned.

The ECB announced new bond purchases on Sept. 12 and increased its charge on bank deposits to -0.5% in an effort to shield the euro zone from a global economic slowdown via a weaker euro and lower borrowing costs.
But it also granted an exemption from that charge on any deposit exceeding six times a bank’s mandatory reserves through a so-called tiered rate on deposits.
That has resulted in banks raising the rate at which they lend to each other over several months, anticipating that some cash will be withdrawn from the market and parked at the ECB when the new rate takes effect Oct. 30.
If this persists, the ECB may have to reduce the amount of reserves subject to the exemption to prevent a rise in borrowing costs in the economy, particularly in countries where cash is less abundant, like Italy.
“The tiering system is having unintended consequences and the ECB may need to lower the multiplier by the end of the year,” one bank treasurer said.
The rate at which euro zone banks lend to each other against collateral for three months <EUR3MRP=> was -0.45% on Monday, compared with -0.50% the day before the ECB cut rates on Sept. 12, Refinitiv data showed.
And the rate applied on repurchase agreements in Italy, the only large country where banks have room to increase their central bank reserves free of charge, was even higher.
Rates on unsecured loans longer than a month, which are used to price some mortgages and derivative contracts, have also risen, as have yields on Italian bonds with a two-year maturity.
“So far, the market developments have not been encouraging … especially in Italy, which was probably not the intention of the ECB when cutting the deposit rate,” said Gilles Moec, chief economist of French insurer AXA.
Tiering the deposit rate was always going to be risky business for the ECB, because of internal imbalances in the euro zone and banks’ lingering reluctance to lend to each other across borders since the euro zone debt crisis of 2011-12.
German, French and Dutch banks are coping with excess cash, while lenders in Italy, Portugal and Greece still borrow more from the ECB than they deposit there.
Italian banks, for example, have capacity to deposit an additional 30 billion euros in excess reserves at the ECB at no cost. Doing so by withdrawing cash from the inter-bank lending market or borrowing more from their peers would drive up rates in the country.
But the ECB still has a weapon in its armory: its next Targeted Long-Term Refinancing Operation (TLTRO III), essentially an auction of cheap multi-year credit, in December.
Pictet estimates that Italian banks could borrow 55 billion to 64 billion euros in new TLTRO loans after repaying existing loans.
This would allow banks that increase lending to the economy to take cash at -0.5% and then deposit at the ECB for free – earning a fast return without draining the money market in the process.
“I think this situation could improve and rates move back down in December when Italian banks can get cheap funds at the second TLTRO III auction,” another treasurer said.
This was far from certain, however, as dismal take-up at last week’s TLTRO auction showed.
Banks have until June to roll over their maturing TLTRO loans into new ones.
“Some will want to wait until June,” the first treasurer said.

(Editing by Larry King)

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