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Ok, so what happens now?

Liquidity is drained from the banks, so are we facing a renewed banking crisis? Will the markets believe that this poses a risk to governments or believe in the common banking resolution mechanisms ability to handle it? And will a speculative attack on exposed governments lead to a renewed periphery crisis or will the ECB back the governments?

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by A swedish kind of death on Fri Jan 24th, 2014 at 08:58:04 AM EST
Voices are being raised asking the ECB to do something already. Draghi said that "an unwarranted rise" of short-term rates would be a condition for additional monetary easing. However, every time SMP sterilization fails to drain the desired amount the inflation hawks freak out. So we have two competing signals: EONIA spiking signals lack of liquidity and SMP sterilization failures, while also signalling lack of liquidity, is mistakenly interpreted as excess liquidity. So this may delay the application of "unconventional" expansionary monetary policy.

The ECB's own metrics are at fault here: their models tell them that unsterilised SMP liquidity contributes to "excess liquidity" in the system.

I wouldn't call this a brewing banking crisis, though. I don't think tight liquidity equates to solvency problems, and the same banks that have been repaying the LTRO could well repo the LTRO assets at the ECB's weekly liquidity auctions which are still "unlimited tender".

So I don't worry too much about a relatively high EONIA figure. The real issue in the Eurozone right now is the geographical fragmentation of lending to the "real economy". Peripheral Euro firms are paying maybe 3% more for bank loans than core Euro firms, and lending volumes are down, and this seems not to be improving.

The "asset quality review" and stress tests to be conducted by the ECB this year should force some banks into restructuring, possibly in Italy and France, maybe even in Germany. Spanish banks are supposed to have just come out of a rescue and "should" be okay, but then again we know the rescue wasn't as big as it should have. So that's where another Bank-Sovereign crisis might occur in the near term.

It should be kept in mind that there is no European bank resolution fund worth mentioning and there won't be for 5 to 10 years. So ultimately the ECB may be forced to trigger the OMT and buy bonds of distressed countries.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Fri Jan 24th, 2014 at 07:26:48 PM EST
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