Misunderstood

• As the ECB did not announce how much it will buy, markets were disappointed...
• However there are some signs of improvement

To tackle the threat of deflation in the eurozone, the European Central Bank (ECB) has triggered Targeted Long-Term Refinancing Operations (TLTRO). It has also announced that it will buy covered bonds and asset-backed securities (ABS) from the private sector. As a result, its balance sheet will expand, but to what extent? ECB President Mario Draghi remained vague on this question. ABS purchases will depend on trends in the securitisation market which is still relatively under-developed (accounting for barely 6% of traded debt in the eurozone, most of which remains sovereign bonds). In the short-term, banks will be encouraged more to retain these securities on their books in order to benefit from TLTRO. As for covered bonds, a share is already in use as collateral for refinancing operations. Given the narrowness of the market on which it has positioned itself, therefore, the ECB will struggle to bring about quantitative easing on a large scale. The expansion of central bank money “M0” will remain limited, which is of concern to the markets. However, it is not so much growth that matters here as the way in which lending responds (and with it M3). Until recently, the link has weakened significantly. But the money multiplier (the ratio between M3 and M0) is now starting to rise again, as is the volume of interbank loans. The money market seems to be showing a little renewed vigour. It is therefore likely that the ECB will keep it under surveillance before deciding to administer the stronger medicine of attempting quantitative easing by buying up sovereign debt.