Euro Area Financial Conditions Continue to Improve, but...
The ECB reports that in the week to Feb 1, its balance sheet fell by 160 bln euros top 2.77 trillion. This is the largest decline since Jan 2009 and largely reflects the early repayment of the first LTRO. It is the smallest the ECB balance sheet has been since just before the second LTRO a year ago.
In addition, new bank borrowing from the ECB has not replaced the longer dated funds. In fact, on Friday, euro area credit institutions did not borrow overnight funds from the ECB for the first time in a month.
As we have noted previously, TARGET2 imbalances have fallen. Recall that TARGET2 is the settlement system in the euro area. During the worst of the crisis, central banks filled the breach left by the break down in the transmission mechanism by which private creditors in the surplus countries funded the current account imbalances of the deficit countries. However, recycling northern Europe's surpluses back to the periphery has seen the imbalances decline.
The Bundesbank's claims fell by 38 bln euros in Jan to 617 bln, which is the least since March 2012 and represents a decline of 18% from its peak last August. Italy's liabilities fell by 27 bln euros in Jan to 228 bln and are the lowest since Feb 2011. Although Spain and Greece have yet to report, it would not be surprising to see that their liabilities also fell a bit in January.
The most recent aggregate data on deposits is for December and there was a notable improvement in the second half of last year. Spanish deposits rose 19 bln in Dec to finish the year at the highest level in a year. Italian deposits rose 41.3 bln euros and finished last year at the highest since Jan 2003. Greek deposits rose almost 6 bln to 156 bln. This was all retail deposits, which stood at 8 month highs in December.
At the end of February, European institutions that borrowed funds under the second LTRO will be able to make early repayments as well. Estimates generally range from 150-200 bln euros. The issue is not simply the reduction of the ECB's balance sheet from the repayment, but also what the freeing up of the collateral pledged to the ECB. Since the collateral is generally assumed to be heavily weighted toward Spanish and Italian sovereign bonds, the question is raised will this impact demand at the government auctions.
Moreover, both Spain and Italy face home grown challenges. In Spain, Rajoy's release of his tax filings has not satisfied his critics. News of his salary increase during the austerity drive does not play well. In Italy, the last polls before the blackout ahead of the election in a fortnight show a tightening race as the Monte Dei Paschi problems hit the center and center-left harder than the center-right. Berlusconi is making a populist appeal, while the PDL has not fought back aggressively. Monti too has not been as forceful as Berlusconi.
Yet the big loser in Europe last week seems to have been France's Hollande. He was rebuffed not once but twice. First, his call for a medium term euro target and his concerns about the strength of the euro were countered by Germany and the ECB. Germany played down the impact of euro's strength and was opposed to political influence. Draghi also seemed not to emphasize the euro's strength, noting that it was near long-term averages. He also seemed to caution against reading much into short-term fluctuations.
Second, Hollande was out maneuvered by Merkel on the EU's budget. Merkel tacked toward the UK's Cameron and achieved the first cut in the EU's budget. France's rebate was cut and as was spending for CAP (the agriculture subsidy scheme for which France is the largest recipient and is the largest single item in the budget). As a partial offset, France did receive an increase in rural development funds. However, with the UK displacing France as Germany's largest trading partner, a potential Berlin-London axis must be a new source of strain for Hollande. Hollande did not do himself any favors by choosing not to attend a preliminary meeting with Cameron, Merkel and Van Rompuy.