Firefighting in the euro zone

April 3, 2013

Money markets largely braved Cyprus’s bailout saga last week, but figures showing liquidity conditions are tightening suggest sentiment may not be as resilient the next time around.

Data from CrossBorder Capital, an independent financial firm that specialises in analysing global liquidity flows, shows the euro zone saw its biggest capital outflow in March since late 2011 – around the time the ECB injected liquidity into the financial system.

Financial institutions and governments took a net $175 billion worth of bonds and stocks, on an annualised basis, out of the euro zone in March – the biggest outflow since $201.4 billion in December 2011, according to the data.

Capital has been flowing out of the bloc since July 2011, the data showed.

Michael J Howell, CrossBorder Capital’s managing director, said:

Liquidity conditions are deteriorating fast and that’s backed up by the fact that if you look at net financial flows into the euro zone they are basically trending lower. The Cyprus situation clearly hasn’t helped.

He said the trend, along with a reduction in the size of the ECB’s balance sheet as banks repaid ECB crisis loans, was reducing the amount of liquidity in the financial system.

That could lead to a funding problem in the region if and when the next flare-up in the crisis comes, he said:

What you’ve got is a series of negatives which are weighing on the funding situation in the euro zone, which means if there is any slight wobble in the market over the next two or three months, you are going to see an upward spike in (interbank lending) rates.

For Howell, the ECB could step up its game:

The overriding lesson that the Federal Reserve has taught us in the last five years is that central bank balance sheets are critical for funding, they are filling a funding gap because the wholesale money markets have, broadly speaking, fallen away. And the Federal Reserve very quickly and in size came in and effectively took the wholesale money markets in the U.S. and put them on its balance sheet (…)

The ECB had done something similar but are showing an “unusual degree of reluctance to go for it,” he said:

What they have done is they have solved a crisis by pumping in liquidity and then as soon as the crisis is over they have taken the money out again. They are just firefighting.



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