ECB Headaches

by Michael J. Howell13. February 2013 12:19

We do not accept the argument that the ECBs operating procedures are so different from the Fed and the BoE that a drop in the size of their balance sheet can be read bullishly simply because it supposedly reflects less take-up of distressed borrowing by banks. Moreover, we cannot see how arguing that the EONIA lending rate lies ‘close’ to the deposit rate floor indicates abundant liquidity. First, ECB balance sheet contraction proved the critical signal for the last crisis and low EONIA rates did not help. Second, the Eurozone money markets are not functioning. Problem banks are still unable to get funding and are forced to borrow at higher rates. Third, in the post-Lehman Crisis World where Central Banks increasingly operate interest rate corridors between lending and deposit rates they are able to control both the level of interest rates and the volume of liquidity. In the US and UK, Central Bankers now realise that greater volumes of liquidity decrease market interest rates. Thus, by flooding the system with liquidity, the Fed has successfully pushed investors back into risk assets. In short, the volume of liquidity maters, and matters a lot. Falling ECB liquidity from E1.67 trillion to E1.5 trillion is thus a bearish and NOT a bullish sign.

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