A new set of cheap loans from the ECB has eased fears about Europe’s banks, pushing down the premium for holding Italian bonds over top-rated Germany and potentially marking a turning point after a shaky start to 2016.
The ultra-cheap targeted long-term refinancing operations (TLTRO), essentially an offer to pay banks to lend to firms, were unveiled as part of the European Central Bank’s latest monetary stimulus plans last week.
Of those measures, the new set of cheap loans will have the most effect on the economy, money market traders polled by Reuters said this week.
“The ECB measures are particularly positive for southern European lenders which normally rely on retail business for their main source of income,” said Gilles Guibout, portfolio manager at Axa Investment Managers in Paris.
Italian bank shares fell sharply at the start of 2016 on fears that no effective way would be found to fix the sector’s bad loan problem, with those worries spilling over into the sovereign bond and credit markets, not least because any bank failure would hurt the economy and government finances. Spanish and Portuguese markets also suffered from concern over bad bank loans.
The ECB’s new scheme, which starts in June, allows banks to qualify for billions of euros of initially free loans from the ECB and get paid up to 0.4% of what they borrow on condition that they lend more to companies or consumers. “This (TLTRO) should remove any concerns about banks’, especially Italians’, capacity to fund themselves,” said Credit Suisse analyst Jan Wolter.
However, negative interest rates, sluggish economic growth and regulation all mean the outlook for banks is far from rosy. In the long run, southern European banks will need more than cheap loans to raise their long-term prospects, analysts said.
“The ECB measures give banks some breathing space but what Spanish and Italian lenders really need is that governments make reforms to kick-start the economy,” said Axa’s Guibout.
But with the latest TLTRO programme, the ECB is again providing a powerful buffer to peripheral markets.
As the graphic shows, Italy’s banking stock index is down more than 25% this year but has rallied about 22% from lows hit in February. The broader European banking sector has recovered about 17% from last month’s lows.
The yield gap between five-year Italian bonds and their German peers, meanwhile, has narrowed more than 10 basis points since the ECB meeting to 58 bps. A move to around 51 bps would mark a post-euro debt crisis low.
The spread between 10-year bonds yields in Portugal, Spain and Italy over Germany have also all tightened sharply.
The Italian BTP/Bund spread is about 105 bps, having ballooned to 155 bps in mid-February when worries over Italian banks became a focus of investor concern. “We think 10-year BTP-Bund spreads could go down to 100 basis points and below because not only now is there an enlargement of QE, but we have the TLTRO which is supportive for peripherals and credit,” said Alexander Aldinger, rate strategist at Bayerische Landesbank. For others, peripheral bond markets are poised to renew their outperformance of top-rated Germany.
“At times people think we’ve landed from Mars when we say Spanish and Italian spreads halve from here but it’s a deadly serious comment,” said Nick Gartside, international CIO of global fixed income at JPMorgan.