ECB Preview: Asset purchases and support for banks – The Governing Council made it clear that it plans to announce a new package of stimulus measures in December.

The exact steps it will take are unclear, but it has signaled that the main goal will be to sustain easy financing conditions for a long period for governments and banks. We have set out our scenario for what we expect in terms of net asset purchases and bank support measures below.

Last month, ECB President Christine Lagarde made explicit what had been implicit over the last year: the real game in town is fiscal policy and the ECB sees its job as facilitating fiscal stimulus at favourable financing conditions.

This means it needs to absorb ongoing heavy supply from public sector issuers next year to ensure bond yields remain low. We think supply will be even higher in 2021 than this year so the ECB needs to be able to conduct aggressive net purchases next year as well.

Against this background, our base case remains for a EUR 500bn step up in the PEPP in December. The amount available in 2021 leftover from the current PEPP envelope is projected at roughly EUR 600bn, meaning total PEPP firepower of EUR 1100bn for 2021.

In addition, we think the ECB will signal net asset purchases will continue for a very long time. The duration of PEPP will be expanded through to at least the end of 2021 and possibly into 2022. On the same theme, we expect the  APP – the program which will likely continue after the end date of the PEPP – to be stepped up by EUR 10bn a month taking the total APP amount to EUR 360bn in 2021.

Meanwhile, we expect the bank package to contain three main elements. First of all, we think that the ECB will raise the amount of excess reserves that commercial banks can hold at the central bank free of charge. Currently, commercial banks are allowed to hold an amount equal to six times (the so-called tiering multiplier) of required reserves. When the Governing Council adopted the tiering framework it noted that it ‘will set the multiplier such that euro short-term money market rates are not unduly influenced. The multiplier may be adjusted by the Governing Council in line with changing levels of excess liquidity holdings’.

Excess liquidity has surged since the tiering system was introduced in September of last year from around EUR 1.8 trillion then to 3.3 trillion currently reflecting the ECB’s aggressive asset purchases, the TLTRO programme and rising private sector deposits. In addition, short term interest rates have also dropped to even below the deposit rate.

Against this background, we think that the tiering multiplier could very easily be increased further. We think this will be done in steps. In December, we expect the multiplier to rise to 8, which would represent a cost reduction of roughly EUR 1.4 billion for the eurozone banking sector as a whole. Looking further forward, the multiplier could be increased to as high as 12 in the coming periods given the outlook for excess liquidity.

The logic in our view of increasing the tiering multiplier is strong. It must be said however that the case for the move has been clear for the last few months and the ECB has refrained from taking the step. This has softened our conviction on whether they will finally do so at the December meeting.

A second measure would be to extend the TLTRO-3 programme by adding a number of tranches, which would create additional opportunities for banks to borrow funds. Under the current plan, the programme has two additional tranches left, one in December and one in March next year.

We  think that the ECB will add three new tranches, in June, September and December of 2021. Given the 3-year maturity of the loans, the last of those tranches would provide funding until the end of 2024.

The third measure would be to extend the period over which commercial banks can benefit from the most favourable lending rate for the TLTRO, which currently stands at -1%. Currently, outstanding TLTRO loans are subject to the lowest rate between June of this year and June of next year.

For the tranches coming up in 2021, we would expect the lowest TLTRO to be available for the full length of those loans, and hence till the end of 2024.

Other options for the ECB would include increasing the volume banks can borrow, reducing the TLTRO rate further (hence below the -1%) and reducing the benchmark for lending performance that unlocks the lowest TLTRO rate. We do not expect any of these changes currently.

The 50% level on the entire stock of non-mortgage lending that banks can borrow is already ample and was increased from 30% in March. Similarly, the lowest TLTRO rate of -1% is already extremely favourable and we think the issue currently is not the level but the length of the period to which it applies.

Meanwhile, the current lending performance threshold of 0% of between 1 March 2020 and 31 March 2021,does not look too stringent based on recent lending trends.