ECB’s inflation battle has a 550 bln euro problem

President of the European Central Bank (ECB) Christine Lagarde addresses a news conference in Frankfurt
President of the European Central Bank (ECB) Christine Lagarde reacts as she addresses a news conference, following a meeting of the governing council of the ECB on the eurozone monetary policy, in Frankfurt, western Germany, December 16, 2021. Thomas Lohnes/Pool via REUTERS

LONDON, March 31 (Reuters Breakingviews) - Euro zone lenders have so far weathered the financial storms blowing in from the United States and Switzerland. That has allowed the European Central Bank to keep raising rates to combat inflation. President Christine Lagarde’s job, however, is about to get harder.

June 28 is a pivotal date on the European banking calendar. On that day, lenders must repay 549 billion euros they borrowed from the ECB’s targeted longer-term refinancing operations (TLTROs) three years ago, during the pandemic.

On the face of it, this should be welcome news for the ECB. The bank is already shrinking its balance sheet by letting its bond portfolios mature. Those TLTROs were made with very favourable interest rates of around minus 1%, making them an anachronism in an era of tighter policy. The ECB once estimated the loans drove down lending rates by as much as 60 basis points, equivalent to a big rate cut.

Yet allowing the TLTROs to simply mature would force banks to fund elsewhere, driving up funding costs. And they are already facing a squeeze, as investors fret more over the impact of higher rates and real estate losses. The extra return, or spread, that investors require to hold bank debt over government securities has risen by some 35 basis points since early March, according to an ICE Bank of America index.

Lagarde has said that euro zone banks are well capitalised and have plentiful liquidity. The problem is that stubbornly high inflation, which hit 6.9% in March, will force her to push the deposit rate higher than the current 3%. That will also make debt financing more expensive for banks.

Policymakers could find a way to ease that pain, without undermining their fight against inflation. To bridge the 550 billion euro repayment, the ECB could offer loans but with a shorter maturity than the original three years and higher interest rates. One option would be to charge banks a premium on the main refinancing operations rate. The MRO – the rate lenders pay for one-week loans from the ECB – is currently set at 3.5%, 50 basis points above the benchmark deposit rate.

Such pricing would ensure that only lenders that really need the funds apply. And it would limit the risk that a splurge of liquidity drives up inflation. Doing nothing may be appealing for the ECB because, as executive board member Isabel Schnabel said this week, lower bank credit would reinforce the effects of rate rises. In the current environment, though, starving banks of liquidity doesn’t seem a risk worth taking.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)


Euro zone banks have to repay 549 billion euros in emergency loans from the European Central Bank by June 28.

The package of three-year loans – part of a wider progamme called targeted longer-term refinancing operations – was one of the ECB’s measures to ease credit conditions and bank lending during the Covid-19 pandemic.

Editing by Neil Unmack and Streisand Neto

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