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For the euro, the big event of the week is the second TLTRO operation. The stakes are high: a big take up would push back QE and help the euro, while a small one  would make it imminent.

So what numbers can we expect? Here is some background, the uphill struggles that the ECB faces and three scenarios and their  potential impact on EUR/USD.

Update:  TLTRO: €129.84 billion – unimpressive – EUR/USD down


The European Central Bank announced a program of targeted loans to banks. Basically, this means that banks get cheap loans, if and only if they lend it to the real economy. The ECB adopted the idea for the Funding for Lending Scheme in the UK. This is different from the original LTRO, that mostly went into sovereign bonds.  Draghi and co. aimed to push around €400 billion into the real economy.

The operation  was set in two operations. The first one was a big disappointment with only €82.6 taken by banks. Some of the blame fell on the stress tests: banks didn’t want to stretch themselves too much ahead of the examination.

In general, the ECB set a target to  enlarge its balance sheet  towards the March 2012 levels, which is around 1 trillion euros using this TLTRO, buying of ABS and covered bonds and potnetially other tools, with the sovereign bond market being the largest one, but the most politcially diffult one.

Uphill Struggles

They are facing an uphill struggle as:

  • Banks continue repaying the LTRO operations from late 2011 / early 2012. This is expected to shrink the ECB’s balance sheet by around €300 billion.
  • ABS is moving slowly: Buying Asset Backed Securities is an ongoing operation, and so far the ECB managed to spend only around 18 billion euros.  The ABS market isn’t that big, and it will take time for this market to grow, responding to the ECB operations.
  • Covered bond operations have the opposite effect: The entry of the ECB into buying covered bonds, has resulted in a fall in yields. And this, in turn, resulted in investors shying away from buying new such bonds. The ECB basically crowded out investors.

So, a lot depends on the second and last TLTRO. If this doesn’t do a big part of the job, falling inflation means that the ECB  would need to go all-in and buy sovereign bonds, outright QE that would significantly weaken the euro. This in turn would also push inflation higher via import prices, and also make exports more attractive.

So, what  numbers should we be looking at?

3 scenarios

  1. Up to €150 billion: Even if the take up  in the second TLTRO is higher than the  first tranche, a figure that is not more than double the previous tranche and below the central forecast of €150 would be a significant disappointment and would make markets feel that QE is imminent after all other means failed. In this scenario, the euro fall. This has a medium probability.
  2. Between €150 to €230 billion: This is already a sizable take up, significantly better than the previous round and leaves room for thought. Markets would likely  see QE  eventually coming, but without any rush, probably not in January.  The ECB could continue its “wait and see” approach for a limited time and the euro could stabilize. This has a high probability.
  3. Above €230 billion: A big take up, that would bring the total TLTRO operation not too far from the original €400 billion would already be considered a success story. It would allow the ECB even more time to assess the effects, and perhaps push back QE forever. This outcome would give a boost to the single currency. This has a low probability.

What do you think?

We will know on Thursday, December 11th, at 10:15 GMT.

For more, see the EUR USD prediction.