Concern over economic impact of €530bn injection

The European Central Bank (ECB) pumped close to €530 billion (£333 billion) in additional liquidity into the financial system last week, although some see the move as little more than a sticking plaster for the wider debt crisis.

On February 29, 800 European banks took the ECB up on its offer of cheap three-year loans through the second long-term refinancing operation (LTRO) with a total of €529.5 billion being drawn down.

The previous operation, carried out in December, saw 532 banks borrow €489 billion. Equity markets rose after the latest LTRO’s strong reception, while yields on eurozone sovereign debt, including Italian and Spanish bonds, fell.

Jenna Barnard, a co-manager of the £1 billion Henderson Strategic Bond fund, says the LTRO is likely to support the “buoyant mood” seen in equity and credit markets.

Barnard says the most significant element of the operation was in the increase in the number of participating banks, explaining: “That shows the ECB’s desire to reduce the stigma of this liquidity facility has worked.”

The LTRO can be viewed in two ways. Advocates argue the more money borrowed the better, as it offers a greater level of support to the system. Critics, on the other hand, say a larger take-up reflects the current weakness of European banks.

Toby Nangle, the head of multi-asset at Threadneedle, concedes that the move lessens the impact of the “collapsed” inter-bank market, saying: “LTRO is to the European banking system what kidney dialysis is to a patient with renal failure.”

However, he argues the LTRO solves none of the bigger challenges facing the eurozone. The LTRO has bought banks time to wind down their balance sheets, but this will have a negative impact on economic growth when coupled with fiscal austerity, Nangle adds.

Jacob de Tusch-Lec, the manager of the £46.7m Artemis Global Income fund, is broadly optimistic about the LTRO. However, he says its ultimate success depends on how long it takes the extra liquidity to trickle down into the real economy through increased bank lending.

“The markets are saying the odds are it will go into the real economy and I suspect the markets are right, but if it doesn’t then we are in for a negative surprise,” the manager says.
“But the reality is it’s harder to paint a picture today that is bleaker than it was six months ago.”