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Unconventional Monetary policy

In several occasions the ECB has repeated that the main target of launching unconventional monetary policy initiative was to re-activate the transmission mechanism of conventional monetary policy (i.e. interest rates). That was needed since the ever easier money was not funneled properly from the financial system into the real economy. Now, with disinflation a reality and deflation looming over the horizon, the message is more radical. Unconventional monetary policy has a blunter aim: expanding the ECB balance sheet “to steer, significantly steer, the size of our balance sheet towards the dimensions it used to have at the beginning of 2012”. Which means, from current levels, an expansion between 700 billion and 1 trillion euro. (see chart)

MACROECONOMICS-Whatever-It-Takes-Part-2-ECB-balance-sheet-evolution

Private QE and T-LTRO

Are those instruments enough for such an expansion?

On September 18th the first T-LTRO take-up was announced. A disappointing 82 billion has to be compared with a market median expectation of 133 and with a theorical maximum of around 400 billion from the first two operations (September and December). It is possible that much more will come in December when, after completing the Asset Quality Review towards the end of October, European banks will be more willing to play this game in size. Anyway, it is also possible that this is an early sign that this new instrument from the central bank is not going to work as desired both in channeling credit to the real economy and in increasing the ECB’s balance sheet. Possible explanations are that demand for credit is not there in a still deleveraging private system and that banks will be less eager to engage in carry trades, as it was the case with the December 2011 – February 2012 LTROs, at current compressed levels of spreads.

If big expansion will struggle to come from the T-LTRO mechanism, it is hard to see a lot coming from the ABS purchases and the covered bond programme, called CBPP3. It has to be reminded that CBPP3 follows CBPP2, active from Nov 2011 until Oct 2012 and CBPP1, active from July 2009 to June 2010. While CBPP1 was fully executed with the targeted EUR 60 billion, CBPP2 was closed early on 31 Oct 2012 at EUR 16.4 billion compared to the originally targeted size of EUR 40 billion. At the time the ECB highlighted that it had “slowed down the pace of purchases in response both to investors’ increasing demand for euro area covered bonds and to the decline in the supply of covered bonds”. Given that, if anything, investor demand for covered bond has increased further since Oct 2012 and the market is facing high negative net supply of two, probably even three years in a row.

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