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Our latest global forecast, published today (free registration required), sees global growth expectations little changed from last month. However, rising inflationary pressures—fuelled by soaring commodity prices—will bring about interest rate hikes sooner than we previously expected.
Namely, the Bank of England is now expected to raise its policy rate in the second quarter of this year. Inflation in the UK has run above the central bank’s 2% target for 14 consecutive months, and we expect it to approach 5% in the next few months. The European Central Bank is now forecast to raise its benchmark rate in the first quarter of 2012, instead of later in the year, for similar reasons.
The US Federal Reserve, by contrast, will keep rates at rock-bottom levels until the second half of 2012.
The data is noisy and, at times, somewhat contradictory. Yesterday, banks’ use of the European Central Bank’s 0.25% deposit facility fell to its lowest level of the year, with “only” €28.5bn parked at the central bank. This can be seen as a sign of renewed confidence among euro zone financial firms, particularly when it comes to interbank lending—banks may be deciding to lend more to one another, instead of stashing cash at the ECB.
However, on the same day, use of the ECB’s 1.75% marginal lending facility hit a two-week high. The previous high, in late September, proved to be a one-off spike. Sustained borrowing at the current level—last seen during the spring, when fears of a sovereign debt crisis reached a crescendo—would suggest that it is still difficult for some European banks to attract private funds. This warrants watching.
The Spanish football team won the World Cup with a strategy that relied on dominating possession. But whereas keeping the ball served the country’s footballers well, a similarly grabby attitude among Spain’s banks is cause for concern.
The latest statistics from the European Central Bank show that Spanish banks boosted their borrowing from the central bank significantly last month, taking €126bn, or nearly 50% more than they borrowed the month before. Euro-zone banks as a whole trimmed their borrowing from the ECB by 4% in June.
As Bloomberg notes, no Spanish banks have sold bonds publicly in the past two months, as jittery markets demand high yields amid fears over the health of Iberian lenders’ balance sheets. Until next week, when the results of the EU’s banking stress tests will relieve or ratchet up these fears, Spain’s banks may take some solace from the country’s footballers, who despite rough treatment eventually emerged victorious.
In its latest Financial Stability Review, The European Central Bank has good news and bad news.
First, the good news. The ECB cut its estimate for cumulative write-downs on euro-area banks’ securities portfolios in 2007-10 by €43bn versus its forecast in December. As it happens, a brighter outlook for much-maligned CDOs contributed the most to this revision.
And now, the bad news. The ECB reckons that write-downs on loans in 2007-10 will be €5bn larger than previously estimated, thanks largely to a worsening picture for commercial property mortgages. Banks in the euro area will write down €123bn on sour loans this year and €105bn in 2011, the ECB predicts.
What’s more, given the “adverse feedback” between public finances and bank balance sheets, the risk of further deterioration in euro member states’ fiscal situation means that “the upside risks to the estimate of potential future write-downs seem to exceed the downside risks,” according to the ECB. As an article at the parent site argues, “the recent improvement in large euro-area lenders’ performance could prove only a temporary respite before sovereign fiscal concerns usher in another bout of stormy weather.”
Central banks in Europe began to offer unlimited dollar liquidity today, as part of the recently re-activated swap line with the US Federal Reserve (see yesterday’s post for details). The results of the auctions suggest that short-term liquidity problems may be limited to the euro zone, for now.
The European Central Bank received seven bids for the eight-day, 1.22% fixed-rate funds. It allotted US$9.2bn in total. The Bank of England and Swiss National Bank offered the same terms but didn’t receive any bids.
In response to the “re-emergence of strains in US dollar short-term funding markets in Europe,” today the Federal Reserve reactivated liquidity swap facilities with central banks in the euro area, UK, Switzerland, Canada and Japan. Announced alongside the €750bn support package unveiled by officials in the European Union, banks’ share prices soared.
The Fed’s facility allows foreign central banks to provide dollar-denominated financing directly to local banks. When interbank lending markets seized up during the depths of the credit crunch, the Fed established swap lines with 14 other central banks. At its peak in December 2008, outstanding swaps were worth more than US$580bn, or around 25% of the Fed’s total assets. (This handy primer from the New York Fed, highlighted by Real Time Economics, explains the history and mechanics of the facility.)
The Fed’s facility was launched in December 2007 and closed in February 2010. It will reopen tomorrow and the take-up by central banks will be closely watched. Signs of stress in interbank lending markets suggest that banks are growing more wary of lending to each other, bringing back bad memories from the months following the collapse of Lehman Brothers.
As previously discussed, credit conditions remain tight thanks to both supply and demand factors. The European Central Bank’s latest survey of bank loan officers confirms this trend in the euro area. When it comes to their corporate clients, banks continue to report both a net tightening in credit standards and a net decline in loan demand.
Looking ahead, lenders expect net loan demand to turn positive in the current quarter. That said, they had a similarly bullish outlook in the previous quarterly survey and, in the end, were proven wrong by a worsening appetite for loans among corporate borrowers.
The plight of Greek banks has been a frequent topic of conversation on this site in recent weeks. Now that the country has announced it will draw on emergency aid from other euro-area countries and the IMF, these lenders—who are heavily exposed to rapidly souring sovereign debt and particularly reliant on the ECB for liquidity—have come under further pressure.
In late trading today, the spread on credit default swaps for Greek sovereign debt soared above the spreads for swaps written on the country’s largest banks. This says less about the safety of the banks than it does about the scale of the Greek state’s fiscal distress.
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Earlier today, Fitch cut Greece’s sovereign debt rating by two notches, to BBB-. This put the country’s banks under further pressure, following a torrid Thursday.
An article on this blog’s parent site investigates the implications for Greek banks. Further cuts to the sovereign’s rating would bring great hardship on the lenders, which rely heavily on pledging government bonds as collateral in return for cheap funding from the European Central Bank.
Read more at Financial Services Briefing: “Refinancing reprieve?” (April 9th)
News that Greece’s largest banks have asked for access to €17bn in funding from a government support fund sent their shares reeling today. The lingering unease over the Greek state’s fiscal situation also flared up, with bond spreads soaring to record highs.
Greek banks are leaking deposits, an unwelcome development when the cost of replacement funds is rising. Markets also continue to worry about the banks’ reliance on the European Central Bank’s special liquidity scheme. Although the ECB announced today that it would continue to accept investment-grade government debt as collateral—some feared an increase in the “haircut” on lower-rated government bonds—it is clear that, eventually, banks will need to wean themselves off of this support or face sharply higher funding costs. Government support funds and continued access to the ECB’s liquidity window will prop up Greek banks for now, but if deposits continue to fall more drastic action may be needed.