Euro zone banks are set to repay nearly 300 billion euros ($310 billion) in loans to the European Central Bank next week, the ECB said on Friday, the biggest cash withdrawal from the euro zone’s financial system in the euro’s 22-year history.
The move is part of ECB efforts to fight record-high inflation in the euro zone by raising the cost of credit and it is its first step towards mopping up even more liquidity next year by trimming its multi-trillion-euro bond portfolio.
The euro zone’s central bank said lenders would repay 296 billion euros worth of the 2.1-trillion-euros, multi-year credit they have taken under its Targeted Longer-Term Refinancing Operations (TLTRO) when they get their first chance to do so on Nov. 23.
This is less than the half a trillion euros that analysts were expecting but still the biggest drop in excess liquidity since records began in 2000.
The one-week ESTR rate, which measures borrowing costs for banks after the repayment goes through, fell after the ECB’s announcement, as did yields on Italy’s two-year government bonds, albeit briefly.
ECB policymakers will look at how the market digests this sudden drop in cash to gauge how fast they can proceed with reversing the ECB’s 3.3-trillion-euro Asset Purchase Programme, which they will discuss at their Dec. 15 meeting.
“These sizeable early repayments reduce the Eurosystem balance sheet and thereby contribute to the overall normalisation of monetary policy, which is needed to bring inflation back to target over the medium term,” ECB board member Isabel Schnabel said on Twitter.
This is the first voluntary repayment window so analysts had cautioned that some bank treasurers may choose to wait until the next one on Dec. 21 to have better visibility on the state of their balance sheet before year-end results.
“The December repayment window may well see larger repayments still,” said Frederik Ducrozet, Pictet Wealth Management’s head of macroeconomic research, estimating reimbursements of 900 billion euros at that window.
While this early TLTRO reimbursement is voluntary, the ECB has given banks an incentive to get rid of those loans by taking away a rate subsidy last month.
The greatest impact from the repayments was likely to be seen in peripheral countries, which would see a bigger proportion of their government bonds come back on the market after being locked at the ECB as collateral for the TLTRO loans.
The other area of focus for the ECB is money markets, in which banks lend to each other for a short time.
Those markets have been hampered by the ECB’s policy for years as banks could not find high-quality bonds to use as collateral for borrowing or did not have an incentive to do so when they could simply tap TLTRO for subsidised loans.
Antoine Bouvet, a strategist at ING, said the lower-than-expected repayment “deals a blow to hope of near term” relief in collateral scarcity.
He and Ducrozet both said the ECB may need to introduce a new long-term funding facility for banks, albeit on less generous terms, if banks come under stress.
($1 = 0.9647 euros)