ECB’s Second Massive Liquidity Injection a Direct Headwind to Euro: Analysts

on March 01 2012 4:32 AM
The Euro sculpture is pictured in front of the ECB headquarters in Frankfurt
The Euro sculpture is pictured in front of the ECB headquarters in Frankfurt Reuters

The European Central Bank’s (ECB) second massive liquidity injection to stave off a credit crunch in the region will be a headwind to the euro over long-term, although the first similar program from the central bank had helped the single currency rebound from its record lows.

The ECB on Wednesday announced its second long-term refinancing program (LTRO2) which provided EUR 529 billion ($710.8 billion) in three-year loans to European banks, a bit higher than its first refinancing offering in December last year.

“The fact that the LTRO came in line with expectations and that asset prices and funding pressures have improved since December makes us confident that the positive effect of this LTRO on EUR/USD will be more limited. As such, we expect less support to the EUR from a lower risk premium,” said a research note from Barclays Capital.

Reacting to the ECB’s liquidity announcement, the euro fell marginally against the U.S. dollar, while it dropped sharply against risky currencies like Australian dollar, Canadian dollar and Mexican peso.

“The ECB balance sheet now amounts to 32% of euro area GDP, compared with 21% in the UK, 19% in the US and 30% in Japan. A weaker EUR vs. the majors is therefore even more likely now and remains one of our core views,” said Barclays Capital.

“We think the massive liquidity injection will become too much of a good thing and more of a direct headwind against the EUR over longer horizons. The EUR could become the funding currency of choice for a wide range of currencies and risky asset positions. This liquidity may put significant downward pressure on euro-area interest rates, which could compress interest-rate differentials even more, presenting yet another headwind to the EUR,” said a note from Standard Chartered.

The first long-term refinancing program from the central bank was able to address liquidity problems in the region’s banking system and played a major role in supporting the rebound in the euro, after the currency came under severe downward pressure amid intensifying sovereign debt concerns in the region.

“While the ECB’s first 3Y long-term refinancing operation (‘LTRO1’), allotted on 21 December 2011, was a ‘game-changer’ for the euro (EUR), we think the second round due on 29 February 2012 (‘LTRO2’) is unlikely to be met with as positive a response,” said Standard Chartered.

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