Draghi must be wary of Ltro elixir’s power
A trillion euros? Half as much – or less? The level of demand in the European Central Bank’s second offer of cheap, unlimited three-year loans to eurozone banks this week will be watched with trepidation by some in Frankfurt. It could shape the presidency of Mario Draghi and his relationship with Germany and its Bundesbank.
Like an elixir discovered by an alchemist, the three-year longer-term refinancing operations have produced eye-catching results for Mr Draghi, who only took office in November. The first, in December, saw the ECB providing €489bn and marked a turning point for the eurozone.
At the time, financial market tensions meant Europe’s monetary union was perilously close to a banking catastrophe. But the three-year Ltro – pronounced, increasingly, “L-troh” – bought time by soothing financial market nerves and boosting economic confidence.
The risk, however, is that too high a sum will shift Mr Draghi’s reputation from the central banker who conjured up breathing space for the eurozone to the central banker who simply spoilt the bankers.
The three-year Ltros were gauged to match banks’ funding requirements and prevent a credit crunch, triggering a deep recession. They have become continental Europe’s answer to “quantitative easing,” operating via banking channels rather than asset purchases. But if demand this week hit, say, €1tn, which is distinctly possible, the suspicion would be that banks were tapping funds primarily for lucrative carry trades – borrowing at 1 per cent from the ECB to invest in higher yielding instruments.
At stake could be Mr Draghi’s relationship with Germany’s conservative Bundesbank. Jens Weidmann, its youthful president, went along with the Ltro programme but voiced concern at the generosity of the ECB’s terms. His fear is not just of giving banks the wrong incentives but that they have become dependent on the ECB’s munificence, reducing the chances of financial markets returning to normal. Banks using ECB funds to buy sovereign bonds could be seen as indirect central bank funding of governments – a sin in the Bundesbank’s eyes.
For Mr Draghi, Mr Weidmann’s worries are ominous. Arguments with the Bundesbank dogged his predecessor, Jean-Claude Trichet. Noisy opposition from Axel Weber, then the German central bank’s president, undermined crisis-prevention measures taken by Mr Trichet: financial markets doubted the ECB’s commitment to act.
Tensions are rising again. The Bundesbank opposed December’s cut in the ECB’s main interest rate. It also objected to the ECB’s stance on its Greek government bond holdings. Mr Draghi secured an exemption from any attempts to impose losses on bondholders as part of Greece’s second bail-out: Mr Weidmann warned that making a special case for the ECB would set a dangerous, legally risky precedent.
An escalation is not inevitable. Mr Draghi has courted the Bundesbank carefully, frequently praising its conservative traditions and Germany’s economic reforms of the past decade. He, says the ECB must respect Europe’s ban on central banks funding governments. The assumption within the ECB is that this week’s three-year Ltro will be the last: the eurozone’s stabilisation has reduced pressure for any further interest rate cuts.
For his part, Mr Weidmann is, to an extent, just playing the role expected of a Bundesbank president by his staff and German public. He knows there are dangers for him in allowing any conflict to flare.
If, as assumed, he has his eye on succeeding Mr Draghi one day as ECB president, he cannot be seen by eurozone political leaders as always taking a minority position. That was the trap into which Mr Weber fell, leading to his resignation last year as Bundesbank president and withdrawal from the race to succeed Mr Trichet.
So both Mr Weidmann and Mr Draghi have an interest in this week’s Ltro acting as a further eurozone stabilising factor – but no more.