Drum roll for TLTRO 3: Five questions for the ECB

June 3, 2019

By Dhara Ranasinghe, Ritvik Carvalho and Josephine Mason

LONDON (Reuters) – – Thursday’s European Central Bank meeting may well see some action to shore up the economy in the form of details on a new round of cheap multi-year loans for banks.

The terms are key given elevated trade tensions, Brexit uncertainty, Italian budget worries and disappointing data.

That also means the ECB will be pressed on what else it can do to combat risks from abroad and low inflation expectations.

Here are five key questions on the radar for markets.

1. How generous will the terms of the new TLTRO be?

Policymakers have said that the terms of a third round of new banks loans, called targeted longer-term refinancing operations or TLTROs, would be decided at one of the upcoming meetings and details could come on Thursday.

The last round of TLTROs in 2016 was priced at the ECB’s minus 0.4% deposit rate, essentially paying lenders for taking the cash. Some officials such as Estonia’s Ardo Hansson have said the terms of TLTRO 3 should be less generous.

There are some reasons for that. Household lending growth hit a post-crisis high in April and corporate lending expanded at its best rate this year, easing fears that banks are shutting off credit amid a growth slowdown.

But the other criteria for assessing a new TLTRO is the broader economic outlook. And there’s no doubt that the balance of risks point down, says Pictet Wealth Management strategist Frederik Ducrozet.

“That’s why I hope for a negative interest rate on TLTRO 3 — Anything close to 0% or above zero would be a massive disappointment and a policy mistake,” he said.

(Graphic: Time to TLTRO, pt. III – https://tmsnrt.rs/2WBhIPI)

2. Will tiered interest rates be up for discussion?

The ECB is considering ways to mitigate the impact of negative interest rate on banks, such as tiered deposit rates that exempt banks from part of the charge for their idle cash.

A discussion is expected this week but don’t expect action soon: ECB board members have hinted they don’t see an immediate reason to introduce tiered rates and view some of the industry’s troubles as it struggles to consolidate and modernize as self-inflicted.

Economists reckon the ECB is unlikely to introduce tiering unless it cuts interest rates again. They add that tiering would only likely offer a limited boost.

“Even the doves on the (Governing) Council are getting cold on the idea so we’re not expecting anything on this,” said Sarah Hewin, chief European economist at Standard Chartered.

For an interactive version of the below chart, click here https://tmsnrt.rs/2EdOcoU.

(Graphic: Excess reserves at the ECB have grown dramatically – https://tmsnrt.rs/2EeKefz)

3. What can we expect from the ECB’s latest forecasts?

In addition to the latest economic projections, this week sees new ECB chief economist Philip Lane present the projections to the Governing Council for the first time.

Better-than-expected economic growth in the first quarter means the 2019 growth forecasts may be revised a touch higher although no significant changes are expected, economists say.

The 2020 forecasts may provide a clearer indication of how policymakers see growth faring in coming months. Trade wars and weakness in key economic indicators such as the Purchasing Managers’ Index (PMI) suggest the ECB will likely reiterate that risks to the outlook remain down, although no change in the ECB forward guidance is anticipated.

For an interactive version of the below graphic, click here https://tmsnrt.rs/2Kd13eC.

(Graphic: More cuts to euro zone forecasts? – https://tmsnrt.rs/2KeFdYo)

4. Will the ECB discuss easing steps if growth and inflation weaken further?

The question is likely to be batted away by ECB chief Mario Draghi, who has maintained the ECB is willing to use all the tools at its disposal if needed.

Still, policymakers are concerned that economic growth is even weaker than feared and that inflation expectations continue to fall, minutes from the April meeting show.

Since then trade tensions, disappointing data and heightened Brexit uncertainty have fueled world recession fears. A key market gauge of inflation expectations is near record lows hit in 2016 around 1.25% and German 10-year bond yields hit record lows on Friday.

This means focus remains on the ECB’s limited toolkit and what it can do if growth and inflation weaken further.

“What clients are talking about is the ECB’s toolbox,” said BNP Paribas chief global economist Luigi Speranza. “The ammunition is there, it’s just how willing the ECB can get a consensus to use it.”

(Graphic: Euro zone inflation expectations close to record lows – https://tmsnrt.rs/2KeQRlX)

5. Will the ECB comment on Italy’s demand that the bank should “guarantee” government debt?

Italy is likely to come up at Draghi’s news conference.

Italian Deputy Prime Minister Matteo Salvini, leader of the right-wing League, has called for the ECB to “guarantee” government debt to keep bond yields low. He’s been more vocal about changing EU fiscal rules too since the League’s success in European parliamentary elections.

The European Commision meanwhile has asked Rome to explain a deterioration in the country’s public finances, setting the stage for a possible clash.

Finland’s Olli Rehn last week rejected the idea of the ECB guaranteeing government debt and ECB Vice President Luis de Guindos said EU budget rules should be obeyed. Draghi is likely to reiterate the tone from fellow officials.

(Graphic: Italy risks flare up again – https://tmsnrt.rs/2KiNWZt)

(Reporting by Dhara Ranasinghe and Josephine Mason; Graphics by Ritvik Carvalho; Editing by Stephen Powell)

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