TLTRO back on the radar

TLTRO 3 is one of the key ECB measures to fight the impact of the coronavirus crisis on the economy, with the aim to ensure that financial conditions remain supportive across the eurozone. The ECB wishes to keep financing conditions “favourable” in the region and is likely to give an update in December 2021 of the future structure of the TLTRO programme. The present TLTRO 3 programme consists of ten tranches, of which nine have already passed. The tenth tranche will be held after the ECB December monetary policy meeting.

The key aspect for the ECB deliberations is that from next June, the rate that it charges will change, as the maturity dates of the TLTRO tranches remain the same. As such, June 2022 will not mark any ‘cliff effect’ stemming from repayments, given that banks officially do not have to start repaying the vast majority of TLTRO borrowings until at least 2023.

Nevertheless, the interest rate on all of the TLTRO tranches will rise to the range of -0.5% to 0% from June 2022 onwards, which will be a pivotal moment. From this date, any bank that has met any of the lending benchmarks will get their TLTRO borrowings at -0.5%, which is in line with the ECB deposit rate, shown in the timeline above. The majority of banks are likely to obtain this -0.5% rate as there are only very few banks that have not met any of the benchmark periods and for these banks this rate would be 0%.

So what will the ECB do?

The ECB has mentioned that it does wish to maintain favourable financing conditions, and it could easily be tempted to offer a bit more to banks. One scenario is that an extra ‘-1% to -0.5% period’ could be applied. This could be greeted by markets as a positive, and would allow banks to continue to have beneficial funding conditions. However, this may not be as beneficial to banks as it would seem at first. Importantly, the ECB requires loan lending to be positive, which will probably be a struggle for many banks given that lending in the eurozone has been rather lacklustre recently. Therefore, far fewer banks than previously would be able to pick up the -1% rate even if it were to be extended.

The problem in terms of the rate discussion above is that the -1% rate was indirectly linked to COVID-19 emergency support, just like the PEPP. With PEPP expected to end in March 2022, it would not be consistent to extend the emergency rate for TLTRO. Indeed, recent central bank comments have been rather mixed, but the French central bank has been the most clear from their October statement about not allowing an extension of the -1% rate, “now that the recovery is well underway, the generous pricing of TLTRO - lending rates can be up to 50 basis points below the average deposit facility rate since April 2020 - is no longer justified.”

Overall, we judge that an extension of the TLTRO -1% rate will not be applied, due to the aforementioned lack of an ‘emergency’ justification. This is our base for the TLTRO future rates. There is a risk to our base case that ECB could slightly tweak the rates, to be something like -0.75% under a transitional justification. More generally, we do expect that the ECB will introduce more TLTRO tranches, albeit at the deposit rate or higher, to assure that financial conditions stay favourable when TLTRO tranche repayments begin. (Tom Kinmonth)