Global Daily – TLTRO at positive rates?

by: Nick Kounis , Bill Diviney

ECB View: Rumours that the TLTRO rate will be positive seem wide of the mark – Market News International reported leaks from ECB officials that the TLTRO terms would be offered at tighter terms than previous operations and as high as 10bp higher than the main refinancing rate of zero. The rationale behind the tighter lending terms was apparently the strengthening of economic data.

We doubt that these leaks if accurate, represent the majority opinion of the Governing Council for a number of reasons. First of all, in the official communication of the ECB, it noted that the loans would be at a ‘rate indexed to the interest rate on the main refinancing operations over the life of each operation. Like the outstanding TLTRO programme, TLTRO-III will feature built-in incentives for credit conditions to remain favourable’.  The latter suggests that if banks meet certain lending benchmarks the rate would be below the refi rate (as in TLTRO-II). Second, a rate of +10bp would make the TLTRO unattractive to virtually all banks in the eurozone when compared to issuing in debt markets. For instance, for most countries, covered bonds in the 1-2 year bucket trade at negative rates and in most cases significantly negative. The exception is Italy, where the rate is around 9bp.  So the vast majority of banks would have no incentive to participate in TLTRO-III unless they could not refinance old TLTRO funds (or not for the total amount) in the covered bond markets. This may well be the case for some Spanish and Italian banks, which have borrowed large amounts in TLTRO-II, but in general a positive lending rate would make TLTRO-II ineffective as a stimulus to incentivise new loan growth. Rather it would be an option of last resort. Thirdly, we think most Governing Council members will remain cautious about the economic outlook. Although GDP growth in Q1 was positive, most data suggest that pace of economic growth is unlikely to be sustained. In addition, downside risks to the economic outlook remain and have intensified given the re-escalation of the US-China trade war.

Overall, we remain of the view that the TLTRO-III rate will be negative conditional on banks meeting certain lending benchmarks. We think that the discussion in the Governing Council will centre on how negative. In particular whether it could go down to as low as -0.4% if banks hit targets, or whether the lowest rate will be slightly higher with the aim of making conditions less favourable than TLTRO-II. Our base is that the rate will be as low as -0.4%. (Nick Kounis)


UK Politics: Crunch week for cross-party Brexit talks – For a time, the Brexit deadline delay to October removed some of the urgency behind attempts to break the parliamentary deadlock, with negotiations between the ruling Conservatives and the opposition Labour Party over a solution now going on for a month. However, the sense of urgency appears to be coming back following the surge in support for the newly-formed Brexit Party, which is being led by prominent Leave campaigner and MEP Nigel Farage. Polling for the European Parliament elections – to take place on 23 May – shows the Brexit Party leading on 34%, with the Conservatives polling just 10% in fifth place. Even in polling for a possible General Election, the Brexit Party is performing surprisingly strongly – Labour is first at 27%, Brexit at 20%, and Conservatives at 19%. Such an outcome would be disastrous for Conservatives, leading to a near-halving in its seats to 179 (Labour would win 316 seats, and the Brexit Party 49 seats).

As a result, PM May has faced renewed pressure to step down, and Foreign Secretary Jeremy Hunt has said it is a ‘crunch week’ for the talks with Labour. A key sticking point appears to be a second referendum, with shadow Brexit Secretary saying any deal would not pass parliament without one, but PM May said to be reluctant to support such a move. Indeed, the rise of the Brexit Party and the haemorrhaging of support from the right flank of the Conservative Party probably reduces the chances of PM May agreeing to such a referendum. Should the talks fail this week – as now looks likely – what would be the next step? The government has committed to holding and abiding by further ‘indicative votes’ (i.e. votes on Brexit Plan B options). While such a process has previously failed to produce a majority in favour of a particular course, the ongoing political realignment in the UK away from the two main parties and towards pro- and anti-Brexit parties might now galvanise MPs to coalesce around a compromise solution. In any case, we continue to think a no-deal Brexit is unlikely, with some variant of PM May’s deal, a softer Brexit involving a customs union, or a second referendum with a Remain outcome the most likely scenarios. (Bill Diviney)