Divyang Shah, IFR Senior Strategist
The continued strength in PMIs makes it difficult for the ECB to persuade markets it is willing to act to arrest the decline in excess liquidity. Both standard and non-standard measures have been sold by the ECB as monetary easing, and it is difficult to justify further easing when the data/economy is getting better.
It may be that the ECB was looking to communicate a willingness to act on excess liquidity to counteract a growing view that interest rates are not going to move lower.
The rationale for creating an asymmetrical bias on expectations comes from the need to strengthen the ECB’s forward guidance. The ECB has been known to use communication as an alternative to adjusting policy in order to create added stimulus.
Assuming the ECB is willing to take action and provide another LTRO, this would have to be justified by highlighting:
1) that the decline in excess liquidity is due to bank deleveraging and thus unwarranted, and
2) a need to strengthen the transmission mechanism, especially for Spain and Italy, where growth is at best flat.
For now, the ECB has told us that it is “particularly attentive” to the decline in excess liquidity, and this in our view will eventually see another LTRO delivered in December, with:
1) a 3-5 year maturity,
2) a fixed or lower rate throughout the life of the LTRO,
3) to include ABS on SME loans, and
4) to come in conjunction with changes to the collateral framework.