The Short View

January 23, 2013 11:14 pm

ECB repayment provides important signals

Investors are back in the groove. Central banks are pouring the drinks, and the party extends to stock markets (just 5 per cent below their 2007 peak in the US, and only a little lower in the UK); junk bonds (lowest yield ever); emerging market debt (where 10 per cent yields are almost extinct); and future volatility (the Vix index of implied volatility on US shares is the lowest since early 2007).

Wednesday brought a new test of confidence: banks had to tell the European Central Bank if they wanted to repay three-year emergency loans early.

These figures are due Friday, and estimates for the first repayment vary widely. But with a weekly option to repay, safer European banks are expected over the next few months to hand back €100bn-€200bn of the €1tn of liquidity the ECB poured into the market a year ago.

Better banks are sure to trumpet repayments as a show of strength. They will also benefit, as many can borrow at less than the effective cost of ECB money, which is secured.

In a sense this hardly matters. Overnight interest rates will be kept down by the vast amount of excess cash sloshing around the system, even if repayments are double what analysts expect.

But the amount of repayment provides important signals. Conventionally, big repayments mean overnight rates will rise back towards the ECB’s 0.75 per cent policy rate earlier than had been thought. Less obviously, foreign exchange traders follow central bank balance sheets closely. With the US Federal Reserve and the Bank of Japan showing no sign of tightening, to put it mildly, shrinking the ECB balance sheet could help the euro.

The euro is close to $1.33 again, and European officials fear currency wars. Less easy money might help the euro, but European complaints should be ignored: against trading partners a euro is worth the same as at its birth in 1999 – and is weaker still when adjusted for inflation.

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