Hair of the dog? Citi says more LTROs in store

April 19, 2012

Just as global markets nurse a hangover from their Q1 binge on cheap ECB lending — a circa 1 trillion euro flood of 1%, 3-year loans to euro zone banks in December and February (anodynely dubbed a Long-Term Refinancing Operation) — there’s every chance they may get, or at least need, a proverbial hair of the dog.

At least that’s what Citi chief economist Willem Buiter and team think despite regular insistence from ECB top brass that the recent two-legged LTRO was likely a one off.

Even though Citi late Wednesday nudged up its world growth forecast for a third month running, in keeping with Tuesday’s IMF’s upgrade , it remains significantly more bearish on headline numbers and sees PPP-weighted global growth this  year and next at 3.1% and 3.5% compared with the Fund’s call of 3.5% and 4.1%.

But its euro zone calls are gloomiest of all. First off, it sees two consecutive years of economic contraction of the bloc as a whole — a 1.0% shrinkage this year followed by 0.2% drop in 2013. Against this dire backdrop, it expects  Spain to be forced to seek Troika (EU, IMF and ECB) support later this year that will be focussed on recapitalizing and restructuring its ailing banks and it also expects both Portugal and Ireland to need second bailouts from the same source.

And with that sort of pressure from deleveraging, austerity, sovereign debt stress and recession , the ECB will have to bring out yet another punchbowl, it reckons.

We expect that renewed EMU strains will prompt the ECB to launch at least one more multi-year LTRO and continue to pencil in one or two more rate cuts by end-2013.

Yet, just like the euphoric effects of both the binge and “morning after” drink, the problem with LTRO is that it risks causing more problems than it solves by tying the banks of weak peripheral euro states ever closer to their ailing sovereigns.

The LTROs provided short-term scope for governments to issue debt at relatively low yields, but have not solved these underlying economic problems. Indeed, with the widespread “home bias” in periphery banks’ purchases of government debt, the LTROs have left the weak periphery sovereigns and weak periphery banks even more closely entwined.

And this is one of the reasons Spain is the first back in focus as euro tensions resurface.

The EBA’s (European Banking Association) late-2011 estimate that Spanish banks need to raise an extra €26bn to cover exposure to periphery debt now looks too low: with the recent rise in periphery yields, we estimate a €30bn capital shortfall based on the banks’ Sep-11 level of bond holdings — and the actual shortfall probably is even higher given the 38% rise in Spanish banks’ holdings of government debt since Sep-11.




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