BOE's Rate-Setter Mann Says Underperforming UK Investment A 'Concern'

Economic

Central Bank

Summary:

Mann was laying out evidence at an event looking into why Britain has suffered one of the worst productivity performances in the developed world.

Bank of England (BOE) rate-setter Catherine Mann said that Britain's lagging investment levels are a "concern" and that the economy is heavily reliant on a small pool of large companies and finance giants to bring in money.

Mann said that just 0.5% of UK firms account for half of business investment, which she said has "underperformed" when compared with other countries.

"UK financiers are concentrated, they are institutional, and they're foreign," Mann said Tuesday at a panel event at the National Institute of Economic and Social Research in London. She said that just three large institutional investors are the key owners of a large number of UK businesses.

Mann was laying out evidence at an event looking into why Britain has suffered one of the worst productivity performances in the developed world. BOE's Rate-Setter Mann Says Underperforming UK Investment A 'Concern'_1

BOE's Rate-Setter Mann Says Underperforming UK Investment A 'Concern'_1

Low business investment has been blamed for the UK's productivity woes, with Brexit seen as worsening the problem and companies shunning listing on London's stock market.

To be sure, business investment has picked up since the pandemic, boosted by generous tax breaks, and Britain fares better when it comes to attracting foreign direct investment (FDI) — points made by those who supported Britain leaving the European Union.

The country remains to top investment destination after the US, pulling in the the second-most greenfield FDI in each of the three years to 2022, trumping even China, according to the Financial Times's fDi database.

BOE's Rate-Setter Mann Says Underperforming UK Investment A 'Concern'_2

Paul Fisher, a former BOE policymaker, said at the same event that the UK's productivity problems pre-date the global financial crisis and could soon be mirrored in other developed countries.

He said the developed world's productivity slowdown is a "long-term trend that is going to carry on" and can be largely blamed on a shift from manufacturing to services in the industrialised world. As manufacturing — which typically has higher productivity growth rates than services — fades as a source of output in developed economies, their productivity growth fizzles out, he said.

He said that the UK's productivity woes could mean it is just ahead of other countries in this process.

Source: Bloomberg

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Stocks

Economic

Market Recap

The US consumer price index (CPI) data came in hotter than expected for the second straight month, proving that there is still some persistence in pricing pressures and that the final stretch of bringing inflation to the 2% Federal Reserve (Fed)'s target remains a challenging process. The US headline inflation came in higher at 3.2% versus previous 3.1%, while the core aspect was down to 3.8% from previous 3.9%, but lacks the progress expected by markets (3.7% consensus). Month-on-month, the core inflation rose 0.4%.

The data will support the view for the Fed to exercise more patience in its rate-cut process, but Wall Street stood unfazed, potentially with the firm belief that its previous recalibration for the Fed's first rate cut to be in June will suffice. Growth sectors recovered from its last Friday's losses, with the S&P 500 delivering yet another record close. The Magnificent Seven stocks are once again the heavy-lifters for market gains, with notable performance in Nvidia (+7.2%), Microsoft (+2.7%), Meta (+3.3%) and Amazon (+2.0%).

Treasury yields reacted higher to the stronger inflation print, with the US two-year yields briefly touching the 4.6% handle, while the US dollar firmed slightly (+0.1%), albeit a lacklustre reaction to the high-for-longer rate narrative. That is sufficient to trigger a downside move in gold prices (-1.1%) however, with the profit-taking amplified by its extreme near-term overbought technical conditions.

Look-ahead: PPI data on Thursday, FOMC meeting next week

We will have the US producer price index (PPI) release coming Thursday, but with markets being so forgiving for the February CPI data, there is a possibility that any higher-than-expected read in producer prices may be shrugged off as well.

The key risk to watch may be the upcoming Federal Open Market Committee (FOMC) meeting next week, where the odds are surely raised for policymakers to revisit their dot plot projections. A potential revision to two cuts this year from the initial three cuts could be likely, as persistence in pricing pressures could feed into higher inflation forecast in its Summary of Economic Projections.

If that plays out, market rate expectations may be due for some recalibration once more, as current pricing still leans towards three to four 25 basis point (bp) rate cuts by the end of this year.

What to watch: US dollar sees more muted response to hotter-than-expected CPI

Initial gains in the US dollar in reaction to the hotter-than-expected CPI were pared throughout the overnight trading session, with the US dollar still hovering around the lower edge of its daily Ichimoku cloud support. Failure to defend the cloud support could reinforce the current downward bias, potentially paving the way to retest the 101.80 level next.

For now, its daily relative strength index (RSI) has dipped below the key 50 level for the first time since January this year, which puts sellers in broader control. On the upside, a move above yesterday's high may pave the way for some near-term relief to retest the 103.63 level next. US Indices Unfazed by Hotter-Than-Expected US CPI Print_1

US Indices Unfazed by Hotter-Than-Expected US CPI Print_1

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Owen Li

Commodity

It's no coincidence that nickel and tin are the two strongest performers in the London Metal Exchange (LME) base metals pack so far this year.

Supply in both markets is dominated by Indonesia, where production and exports are being affected by delays in approving annual work permits.

This is a relatively new phenomenon for nickel. Indonesian production has exploded over the last few years to the point the country now accounts for more than half of global supply.

Tin has been here before. Indonesia has long been the world's largest exporter and the flow of metal to world markets has been interrupted several times in the past when the government tightened production and export rules.

Tin's misfortune, however, is that its supply chain is not just beholden to Indonesia's resource nationalism but also to that of the Wa State in Myanmar.

Double Trouble

Indonesian exported 78,000 metric tons of refined tin last year, equivalent to around a fifth of global demand.

Exports so far this year have slumped to just 55.4 tons, compared with 4,700 tons in January-February 2023.

The last time shipments ground to a complete halt was in August 2015, when the authorities introduced "clean and clear" rules on exports to enforce environmental standards.

This time it's a change to the annual permitting system. It's possible that tin may be coming under special scrutiny due to an unfolding illegal mining scandal.

The government has also made no secret of its intention to limit exports as a lever to push its tin sector further downstream.

It doesn't seem to have worked out how to replicate its nickel strategy in the tin market yet. But the threat to the rest of the world's tin supply is not going away.

Neither is that posed by the Wa State, the semi-autonomous region of Myanmar which controls the Man Maw mine, one of the world's largest tin resources.

All mining was suspended in August last year to allow for an audit of reserves. The suspension has been partly lifted for some smaller operators, although they will pay more in export tax, according to the International Tin Association (ITA).

However, operations at Man Maw have yet to resume. The ITA suggests the delay may reflect a policy re-think around the need to replenish the Wa government's strategic stockpile.

Amid the continuing uncertainty, one thing is clear. The ruling United Wa State Army aims to exert tighter control over the jewel in its mineral crown.

Myanmar and Indonesia are combining to squeeze global tin supply driven by the same resource nationalist impulse.

Surplus And Stocks Rebuild

The tin market can likely absorb the double hit over the short term.

The ITA estimates that global supply exceeded usage by 9,700 tons last year, attesting to the slump in demand from the electronics sector, where tin is used as circuit-board soldering.

Stocks registered with the LME and the Shanghai Futures Exchange (ShFE) more than doubled to 15,400 tons over the course of 2023.

Those on the LME have recently been sliding as the halt to Indonesian shipments drags on. Headline inventory has fallen by 31% to 5,300 tons since the start of January.

Shanghai stocks, by contrast, have continued growing over the Chinese New Year holiday period and at a current 11,072 tons are the highest they have been since ShFE launched its tin contract in 2015.

The flow of raw material from the Man Maw mine in Myanmar to Chinese smelters has dropped but not as much as feared after the authorities allowed the processing of surface stocks. Many Chinese operators also built up stocks of concentrate ahead of the August suspension.

China's production of refined tin grew by 1.8% year-on-year to 169,000 tons, according to local data provider Shanghai Metal Market.

Tin users are lucky that the current supply disruption has come after a year of low demand and restocking of both raw material and metal.

Future Fragility

The question worrying the tin market is how long it will be before normal supply service is resumed in both Myanmar and Indonesia.

LME three-month tin hit a seven-month high of $27,810 per ton on Friday and, currently trading around $27,460 per ton, is now up by 9.0% on the start of the year.

Even assuming a speedy resumption of Indonesian exports and mining in Myanmar, tin supply over the next few months looks challenging.

The longer-term threat is of future supply disruption as resource nationalism drives both governments further down the road of export controls.

Tin's use as a circuit-board solder makes it a critical mineral both for the current generation of electronics and the coming internet of things.

Yet it is one with an incredibly fragile supply chain, beholden to the politics of Indonesia and the United Wa State Army.

This year's supply squeeze may be just a taster of things to come for tin.

Source: Mining

Risk Warnings and Disclaimers

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Alex

Stocks

Economic

By some measures the U.S. stock market has not been this top-heavy in over 100 years and has just had one of its strongest rallies in decades, giving understandable rise to fears that a potentially large correction is imminent.

History suggests these fears may be overdone.

In the year following previous periods of extreme concentration, the S&P 500 rose more often than not, while rallies like the one just recorded over the past four months are always followed by 12 months of double-digit percentage returns.

Of course, no two macro or market environments are the same. And if the post-2008 and post-pandemic world has taught investors anything, it is that past performance is definitely no guarantee of future outcomes.

Still, they can provide useful guidance.

Concentration within the U.S. equity market has not been this high in decades, with the 10 largest U.S. stocks now accounting for 33% of S&P 500 market cap. A narrower measure constructed by analysts at Goldman Sachs shows that market concentration has never been higher. Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_1

Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_1

Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_2

S&P 500 returns in the 12 months after the 1973 and 2000 crashes fell 23% and 18%, respectively. But over seven periods of extreme concentration in the past century, including 1932, 1939, 1964, 2009 and 2020, average returns were 23% higher in the 12 months after.

"Historical episodes of elevated concentration were followed by S&P 500 rallies more often than corrections," notes Ben Snider, senior strategist at Goldman Sachs.

Comparisons with 2000 abound, but there are reasons to be optimistic. Snider calculates that the median valuation of today's top-10 stock is substantially lower than the comparable median in 2000, and the median top-10 market cap constituent is nearly three times more profitable than it was in 2000 or 1973.

The average S&P 500 stock is also relatively cheap. Analysts at Truist Advisory Services estimate that the S&P 500 Equal Weight Index is trading at a 20% discount to the traditional S&P 500, which is dominated by these mega tech and growth companies.

They say the equal-weighted index is showing signs of stabilizing after a period of underperformance, and reckon adding exposure to the equal-weighted index is one way to diversify within large caps.

Smaller caps are trading at an even deeper discount and are now near "extreme undervaluation" territory. If earnings momentum picks up, this is another sector in prime position to share the load.

Sit Tight

Market concentration in itself is not a sufficient trigger for a large drawdown. Nor is a long and steep rally.

By some measures, U.S. stocks are enjoying one of their strongest rallies in over 50 years and one of the strongest on record. The S&P 500 just rose 16 out of 18 weeks, a feat not achieved since 1971, gaining almost 25% in the process.

A period of consolidation or a near-term pullback would almost be expected, and Nvidia losing more than 10% of its value since Friday may be the first sign that one is underway.

Analysts at Deutsche Bank say there have been five other episodes since the World War Two where the S&P 500 rose 21.5% or more in four months. Four were when the economy was emerging from recession, and one was during the dotcom bubble.

"So, you probably only need to worry if you think tech is in a bubble or if the recession has merely been postponed," wrote Deutsche's Jim Reid last week. "A relentless and aggressive rally is not in itself enough to justify a big correction." Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_3

Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_3

Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_4

Peak U.S. Stock Concentration Doesn't Mean Steep Drawdown_5

But what if investors do take fright and start selling?

There is no template for what a drawdown looks like and history shows they come in all shapes and sizes. Recovery periods, the gap between the market's high-water mark and when it is next breached, vary wildly too.

The largest drawdown was 1929-1932 when stocks plunged 79% in real terms and full recovery, including reinvested income, wasn't achieved until February 1945, more than 15 years later.

The full drawdown and recovery from the dotcom crash of 52% in real terms lasted 7-1/2 years, while the market recovered its 35% real terms pandemic slump in 2020 within five months.

Investors' drawdown tolerance depends not only on their risk tolerance but their investment horizon - economic, financial and political crises come and go, but in the long run stocks tend to rise.

If you have the stomach and patience to ride out the volatility, sitting tight is perhaps the best policy.

"The largest drawdowns, like 2008, 2020, or even 2022, were usually sparked by a major shock. But we would always caution against panic and selling, especially for longer-term clients like pensions, retirement accounts, endowments," said Olaolu Aganga, U.S. chief investment officer at Mercer.

Source: Reuters

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Cohen

Bond

Central Bank

The Bank of Japan will likely offer numerical guidance on how much government bonds it will buy upon ending negative interest rates and yield curve control (YCC), to avoid causing market disruptions, said four sources familiar with its thinking.

With inflation exceeding the BOJ's 2% inflation target for well over a year, many market players expect the central bank to pull short-term interest rates out of negative territory either next week or in April.

Upon ending negative rates, the BOJ is also likely to ditch yield curve control (YCC) - a policy that guides the 10-year bond yield around 0% with a loose cap of 1%, the sources said.

While such a step would allow market forces to play a bigger role in bond price moves, the BOJ will likely provide guidance on the pace of bond buying to prevent long-term interest rates from rising too much, the sources said.

"The BOJ would have to keep buying government bonds to some extent, and present some form of guidance to avoid any abrupt spike in yields," one of the sources said, a view echoed by another source.

"The BOJ will likely use bond buying as a backstop against unwelcome spike in yields," another source said, adding that setting a loose quantitative guidance would be among options.

Currently, the BOJ does not set an explicit target on the amount of bond purchases. But it buys roughly 6 trillion yen ($40.7 billion) worth of government bonds per month to achieve its yield target.

The central bank is likely to roughly maintain the current pace of bond buying after ditching YCC, and forgo sharp cuts in the amount for the time being, the sources said.

As part of efforts to reflate growth and fire up inflation to its 2% target, the BOJ deployed a massive asset-buying programme in 2013 under former Governor Haruhiko Kuroda.

As the inflation target proved elusive, the BOJ began applying in 2016 a 0.1% charge on financial institutions' excess reserves under its negative rate policy. It also adopted YCC in September of that year.

Upon ending negative rates, the BOJ will likely set the overnight call rate as its new policy target. By paying 0.1% interest on reserves parked with the central bank, the BOJ will guide the overnight call rate around zero, the sources said.

With a near-term exit from negative rates seen as a done deal, market attention is shifting toward any clues the BOJ may give on the pace of subsequent interest rate hikes.

But the BOJ is likely to forgo offering explicit guidance on how soon it will hike rates again due to uncertainties over the economic outlook, the sources said.

BOJ Governor Kazuo Ueda has said the central bank will maintain accommodative monetary conditions even after ending negative rates, and avoid causing any "discontinuity" from the current ultra-loose policy.

Any guidance on the future policy path will likely be in line with such comments, the sources said.

As for the BOJ's risky asset buying, Deputy Governor Shinichi Uchida said in February that it was natural for the purchases to be discontinued when conditions fall in place to phase out the bank's massive stimulus programme.

($1 = 147.3000 yen)

Source: Yahoo

Risk Warnings and Disclaimers

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Zi Cheng

Traders' Opinions

Forex

Fundamental Analysis

The most recent core CPI figures for February in the US have prompted caution from the Federal Reserve regarding the possibility of early rate cuts. Despite this, there are still two months left before June, leaving room for the data to influence the Fed's decision. Market forecasts for rate cuts throughout the year remain steady at approximately 80-90 basis points, closely matching the Fed's projected 75 basis points cut. Consequently, there has been only a slight increase in 10-year yields.

USD/JPY Remains Strong Above 200 Moving Average_1

Additionally, the NFIB Small Business Optimism Index experienced a slight decline to 89.4 in February from 89.9 in January, indicating continued subdued sentiment among small businesses. This suggests that labor market conditions may be weakening, potentially restraining inflation in the service sector.

Traders are working under the assumption of a "loose-policy asymmetry," believing that the Fed is comfortable with allowing inflation to stay above target without immediate action while being prepared to implement multiple rate cuts by year-end, with minimal chance of another hike. This perception of a "Fed Put" has resulted in various assets reaching record highs as investors feel confident in pursuing high-risk opportunities without the fear of higher interest rates. The Fed's apparent lack of concern about the risk of a positive wealth effect reigniting demand-side inflation further supports this sentiment.

Meanwhile, in Japan, BOJ Governor Ueda has reiterated the nation's gradual economic recovery despite some signs of weakness. This suggests that the BOJ is on course to exit its negative interest rate policy, with expectations of a rate hike as early as the March meeting following this Friday's announcement of the outcome of the annual wage negotiation.

The Japanese yen began trading at 147.60 and was sold into the Fix at 147.30, indicating expectations from Tokyo FX desks for spot and forward selling from local exporters throughout the day. With US June Fed rate cuts still confirmed and the BoJ leaning towards a hike next week, this directional trend aligns with expectations of a stronger yen.

Technical Analysis

USD/JPY was a strong uptrend previously but the trend reversed at the strong resistance level and retraced all the way back down to the 200 Day Moving Average indicator. It is a crucial level to watch USD/JPY as if it breaks the support level and goes below the 200 Day Moving Average, there is a high possibility we could see lower prices on USD/JPY.

However, if you have a buy bias, I would recommend to stay calm and wait for USD/JPY to break the resistance trend zone which shows that the buyers are back in the market and ready to push price higher.

USD/JPY Remains Strong Above 200 Moving Average_2

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ING

Economic

Central Bank

The level of MRR in focus in the review

ECB President Christine Lagarde confirmed in a press conference last week that the central bank aims to reach a consensus to complete the review of the operational framework on 13 March and publish it thereafter. She also confirmed that the Minimum Reserve Requirements (MRR) would form part of the review and the announcement.

ECB speakers have discussed the level of the MRR on several occasions. Expectations for any changes to this, however, were downplayed yesterday. According to Bloomberg, which cited people with knowledge of the matter, ECB officials are leaning against any immediate change to the MRR. A push by some members to increase the requirement from the current 1% level has struggled to gain momentum, according to the article. That being said, the article notes that no decision has yet been taken, and even if the level is confirmed this week, officials haven't excluded the prospect that it could be raised in the future.

Banks have now enough central bank deposits for an MRR hike…

Eurozone banks must set aside c.€161bn as minimum required reserves to meet the 1% requirement as of March 2024. An increase to 2% would double the level unless it came with action by banks to drive down their individual absolute requirements. An increase would have been negative for bank profitability as the ECB doesn't pay interest on funds posted for the MRR.

Looking purely at current and deposit accounts, eurozone banks are well positioned for a potential (modest) increase. In all countries, banks could absorb an increase to 2%, and this is also the case if adjusting for the outstanding ECB funding programmes. In all eurozone countries, Italian banks would have the least room for a higher MRR, in our view. Even in Italy though, with the current net central bank liquidity, the sector could absorb an increase even to 3%, based on our calculations. How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_1

How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_1

…but an MRR hike would have a substantial negative impact on LCR liquidity buffers

Funds posted to meet the MRR can't be used to fill LCR requirements, meaning that an increase will have a clearly negative impact on bank Liquidity Coverage Ratios (LCR).

The latest available LCR metrics at the eurozone level are for 3Q23. Adjusting the LCR for the increase in MRR would result in an LCR decline of some 9ppt on average. The LCR ratios would remain well ahead of the 100% requirement. Among larger countries, German and French banks would see their LCR ratios at the lowest end of the pack, while Southern European banks would retain higher average LCRs. How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_2

How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_2

LTRO repayments continue to drive down LCRs

The 3Q23 LCR ratios look inflated due to the ECB's TLTRO-III programme. Going forward, we expect the ratios to continue to edge lower as banks repay their TLTROs.

If we adjust the 3Q23 LCR liquidity buffers with the LTROs that were outstanding at the time, assuming a full repayment with existing liquidity buffers, the LCRs would be, on average, some 16% lower than the reported levels, with the largest impact on Italy and Greece. Italian banks would see their LCR ratio edge lower towards 116%, with Germany and France also positioned at the lower end of the spectrum here.

If we adjust the LCR liquidity buffers for both the maturing LTROs and a higher MRR rate, the LCRs would be on average some 25ppts lower than the actual reported ratios. The difference would again be the largest for those countries with larger TLTRO balances outstanding such as for Italy or Greece. While the country-level LCRs would remain above 100%, the headrooms would be undoubtedly much more limited. How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_3

How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_3

Banks have protected their liquidity buffers while repaying the ECB

The reality would likely be somewhat less negative than this as banks have taken action to refinance part of the TLTRO redemptions outside the central bank.

Since 3Q23, eurozone banks have paid back a combined €102bn in longer-term central bank funding as the TLTROs have continued to mature. During this time, French banks have paid down the largest share at €27bn, followed by Germany (€20bn), the Netherlands (€17bn), Italy (€14bn) and Spain (€10bn).

At the same time, banks have increased their central bank deposits by €36bn. In particular in Germany, Austria and Italy, the net change in liquidity has been positive, while in the Netherlands and France, the net change has been negative. How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_4

How The ECB's New Operational Framework Could Impact Bank Liquidity and Funding_4

Another €216bn in TLTROs mature in March and €177bn later this year

The negative impact on liquidity buffers from the LTRO redemptions is set to continue. The TLTRO-III tranche 7 which matures on 27 March 2024 is currently the largest outstanding TLTRO tranche with €215.5bn in outstanding balances. In addition, a 3m tranche with €1.1bn balances redeems on this date. The next TLTRO-III early repayment opportunity is also offered in connection with these maturities.

For early repayments on 27 March in tranches 8-10, banks will have to notify the national central bank by 13 March at 17.00 CEST. We would not expect large early repayments, particularly in the longer tranches in March. Instead, we would expect the early repayments to be concentrated in the shortest tranche 8 that redeems in June. The early repayment amounts will be published on 15 March.

Banks have prepared for the approaching €216.5bn LTRO redemptions (TLTROIII.7 and the 3m LTRO) via active issuance in the bond markets. After the March redemption, (prior to any potential early repayments) the size of the TLTRO-III programme drops to €177bn, split between June (€53bn), September (€85bn) and December (€39bn).

Italian banks have €141bn in outstanding TLTROs which are set to mature in 2024, the highest across countries, followed by France at €96bn and Germany at €69bn.

Repayment of LTROs may impact liquidity buffer composition

The LTRO runoff and potential MRR changes may impact the level of liquidity buffers but also potentially the composition of these buffers.

Repayment of LTROs with existing buffers would have a direct negative impact on LCR cash balances, while the holdings of high-quality bonds remain unchanged. A potential increase in MRR would also impact negatively the LCR cash buffer, while other liquidity buffers would remain intact. These factors could have implications for bond holdings in liquidity buffers.

The LCR stats published by the ECB don't include the split of cash vs govies. To get at least some sort of broad picture on the potential split we adjust the cash and central bank deposits on significant institutions' balance sheets with the MRR and compare the number with the total LCR buffers. While you should treat these numbers with some caution, they may give some idea of the direction. On average banks rely to a large extent on cash in their liquidity buffers with the share at 66%. That being said, country differences are large with banks in Southern Europe relying perhaps less on cash than their more Northern counterparts.

If we adjust the assumed cash positions with a full repayment of outstanding LTROs, the share of cash in LCR buffers substantially declines towards an average of 61%, with the largest impacts obviously for banks with larger outstanding LTROs (as of 3Q23 to align with LCR numbers) such as in Italy and Greece. We also adjust the numbers for a potential increase in the MRR to 2%. The share of cash would be some 2ppts lower on average, with Portugal, Belgium, Italy and Greece among the countries with a tad larger impact.

As banks may have internal targets to maintain a certain share of cash versus other liquidity buffers, a substantially lower share could result in banks taking measures to adjust the ratios higher again. This could be reflected, for example, in pressure to refinance maturing LTROs or convert other liquidity buffers such as government bonds into cash.

Check also for the future plans regarding the funding operations

Indications on the refinancing operations are also worth a careful look. Earlier press reports suggested that the ECB aimed to revive the interbank market with its new monetary policy framework. The design was meant to allow the ECB to run with a smaller balance sheet size and still deliver stable funding conditions for banks, relying on a structural bond portfolio and bank loans to provide sufficient liquidity.

Banks are meant to be able to participate in refinancing operations, with durations anticipated to be similar to offerings in the past, according to a Bloomberg article published in late February. In addition, maintaining the current policy of satisfying all bids at a fixed rate was said not to have faced any major objections.

In the past years, banks have been offered liquidity via the MROs and LTROs with the durations ranging between seven days to up to three months for the standard operations and up to three years via the targeted longer-term refinancing operations.

Banks have relied very heavily on the ECB in recent years for funding, but this has been driven almost solely by the attractive conditions of the longer-term funding programme TLTRO-III. The programme provided some €2.3tn of funding to banks at its peak, with the volumes dropping to €392bn as of end-2023 with the programme set to mature by the end of this year.

Instead, bank drawings from the three-month tranches have been much smaller in size, currently around a combined c.€5bn. The even shorter seven-day funding via the MRO has also been used to a limited extent with the current drawings at around €4.5bn, coming down from above €14bn at the end of the year.

Based on the press reports, it sounds likely that there will be limited changes to the funding programmes in the shorter term. That being said, while news reports have suggested that the ECB could offer similar durations to the past, it could well be that, if the central bank is targeting a smaller balance sheet size, conditions for any new longer maturity funding could be less attractive than those seen previously.

An unchanged MRR should be seen as a positive for the sector

We consider that if the ECB keeps the MRR level unchanged, as was indicated yesterday, it should be seen as a positive for eurozone banks.

An increase would have been negative for bank profitability as the ECB doesn't pay interest on funds posted for the MRR. Keeping the MRR unchanged should also allow banks to better absorb the other negative impacts on liquidity that are in the pipeline for this year. Liquidity buffers are being hit by a combination of TLTRO repayments, deposit volatility driven by higher rates and by the government measures targeting retail deposits among others.

It is good to note that the formulation in the article published yesterday regarding the MRR level leaves some room for the ECB to revisit the level at a later stage, resulting in a somewhat negative overhang on banks regarding the matter.

Alongside the MRR, we consider that maintaining similar funding programmes could be seen as neutral or perhaps even mildly positive for the sector. Any push from the ECB for banks to move more towards financial markets from central bank funding would benefit stronger banks at the expense of weaker rated names in our view, pushing up rates on other bank funding products.

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