To recap, two major measures were taken: 1) a reduction of 50 basis points in the cost to banks obtaining dollar funding through the ECB, and 2) the announcement of two 36-month refinancing operations, designed to provide unlimited long-term funding to banks.
Dollar loans
The first measure looks to have considerable success with 34 banks obtaining $50.7bn in three-month loans from the ECB at the first three-month US dollar tender since cutting the penalty rate; that compares to prior expectations by analysts of $10bn being demanded.
This highlights the incredible demand by eurozone banks for dollar funding and the move away from euro funding, a trend unlikely to reverse near term. Even after the ECB announced the 36-month lending to banks in euros (with a lowering of acceptable collateral), banks still appear to be demanding dollars (witnessed in ongoing widening in the euro/dollar cross-currency basis which shows the cost banks pay for dollar funding).
Other indicators also highlight that funding pressures remain elevated in the eurozone interbank market. The euro libor-OIS (overnight index swap) spread – an indicator of short-term interbank funding stress – remains at the post financial crisis highs.
In reality, the market for unsecured funding between banks is shut with banks nervous to lend to other eurozone banks for even just three months. With interbank funding closed, the ECB is quickly becoming the only avenue for banks to source funding. Medium-term financing by the ECB should reduce the threat of an imminent bank failure but improving investor confidence in bank solvency will likely require lower yields on troubled eurozone sovereign debt.
Interbank lending
Overall, the threat of a disruptive banking event has reduced in the short term, but the lifeline of medium-term liquidity support will likely not be enough to reopen the interbank unsecured funding market.
While direct purchasing of sovereign bonds by the ECB remains low, the above mentioned non-standard measures adopted are encouraging banks in Spain and Italy to purchase their respective sovereign – a 1% financing cost by the ECB for three years to purchase a three year Spanish bond yielding at the time over 5% is apparently incentive enough.
In Spain, yields on one-year bonds have dropped by 120 basis points on the week, with two and three-year maturities dropping by around 100 basis points.
In Italy, the reaction has been somewhat more on the muted side, but nonetheless the fall in yields at the short end of the curve has been of the order of 50 basis points or more.
Equally, the local investor base in both countries continues to support the new issuance market quite well.
