Overnight the ECB offered its next round of its uncapped long term refinancing operations, or 3-year LTRO:
As you can see from the chart above, last night’s operation was for €529.53bn, which was larger than the €489.19bn allocated in stage I. As with the first operation, the headline number hides quite a bit of detail because the 3 year operation contains quite a lot of rollover out of other shorter term operations. Taking into account these rollovers, the estimated net increase in euro reserves from this operation is €311bn which, if we add to the €209.9bn provided in stage 1, means that these 3-year operations have added approximately €521bn in reserves in total. It is expected, as we saw from the first operation, that these reserves will flow into the ECB’s excess reserve facility which means tonight we should get some verification on the final numbers when the ECB reports that data.
Interestingly, the number of institutions using the facility was up from 523 to 800. Of course, as with stage 1, the question is what the banks will do with the additional liquidity, and what effect it will have on the markets and the real economies of Europe. If stage 1 is anything to go by then we will see a broad rise in all markets, but a deleveraging in the real economy. However, it must be noted that this was always going to be at least a two stage operation and therefore the banks always knew they had a second bite of the cherry coming. Given that it is not clear whether there will be another round of these operations, the behaviour of these institutions may change in response to this second round of money. Obviously that behaviour will flow on to sovereigns, and one of my outstanding questions of these operations is: What happens after February given that banks now have less incentive to purchase sovereign paper over other assets?
What is clear is that the European banks still have a long way to go in order to meet their capital requirements under Basel III, which means we are likely to see a continuation of the “credit crunch” dynamics in the periphery, and therefore a continuation of the financial stress in the European system.
As I mentioned again yesterday, I am concerned that Portugal is well on the way to becoming the second Greece and action in the bond markets overnight suggests concern is spreading about the long term viability of the country.
But the markets do not appear to be the only ones worried about Europe’s long term viability under current arrangements. Back in December, while assessing the new “fiscal compact”, I made the following statement:
So while there is no credible counter-balance for the effects of supra-European austerity, any attempt to implement the new “fiscal compact” will make Europe’s economic issues worse. The continent is already on the way to recession and unless we see some additional action from the ECB, or a huge swing against this new framework, the push to implement the outcomes of the summit will simply accelerate that outcome. My assumption is that, if Europe does ratify this framework (there are a few stragglers), after 12-24 months of trying, the effect will be so disastrous that they will eventually give up. But until then my base case for Europe is a significantly worse economic outcome.
We already know that Ireland is to hold a referendum on the fiscal compact, but that is not the only push back occurring. It also seems, I assume under some steerage from the likes of Mario Monti, that Spain is joining in:
A push by Spain for more leeway in meeting its 2012 budget deficit has opened a rift between the European Commission and several EU member states, with the Commission adamant that countries’ targets should not be relaxed, senior EU officials said.
Spanish Prime Minister Mariano Rajoy is hoping major EU states will back him at a summit on Thursday and send a signal that Madrid’s target of cutting its deficit to 4.4 percent of GDP this year should not be binding.
Spain said this week its 2011 budget deficit was 8.5 percent of GDP, substantially higher than previously expected, making the 2012 target all the harder to achieve.
But the Commission, which is responsible for overseeing euro zone budgets, is not willing to show flexibility, at least until Spain explains why the 2011 deficit was so much higher than expected and puts forward new austerity measures.
“We are not talking about giving more flexibility to any member state when it comes to fulfilling commitments,” Commission spokesman Olivier Bailly reiterated on Tuesday.
But two senior officials told Reuters that Germany, France, Britain and a handful of other countries were supporting Rajoy’s push for a softening of the 2012 target.
I expect to see much more of this as it become apparent that Portugal’s troubles are leaking into Spain.