A record 3 trillion euros looking for a home

London

THE emergency stimulus by the European Central Bank (ECB) has propelled excess cash sloshing around the euro area's economy past 3 trillion euros (S$4.77 trillion) for the first time.

Financial institutions have increased the amount of money parked with the ECB by a trillion euros in under six months, said the central bank's latest liquidity update. It comes after policy makers issued cheap loans to banks and snapped up bonds to offset the economic damage from the coronavirus pandemic.

Liquidity conditions became exceptionally loose when the ECB started charging interest rates as low as minus 1 per cent for Targeted Longer-Term Refinancing Operations or TLTROs, to aid the economic recovery from the pandemic. That means the central bank is effectively paying for the money to be lent out.

Whether banks hoard the cash for a rainy day, or lend it out to stimulate the economy, almost all of the money is stored as reserves at the central bank, boosting excess liquidity. Spare money in the system has climbed to 3.085 trillion euros, going by the latest ECB figures.

"Money doesn't leave the system," said Rishi Mishra, an analyst at Futures First.

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Excess cash had already pushed the region's short-term rates to all-time lows, narrowing the difference between three-month Euribor - the rate that banks can theoretically borrow from each other - and the overnight rate Eonia, seen as a measure of funding stress, below zero in July for the first time since 2005.

The Euro Short-Term Rate, known as ESTR, slid 1.4 basis points to minus 0.57 per cent on Wednesday, breaking the previous record low set a month ago. Euro zone banks took 174.5 billion euros of TLTRO loans last week, adding to the 1.3 trillion euros of borrowings in June. They have also sold 559 billion euros of debt to the ECB under the pandemic purchase programme.

Euro-zone inflation for September is expected to show another decline in prices on Friday, according to the median estimate of economists. While previous large increases of cash in circulation have pre-empted a fall in consumer prices, Christoph Rieger, head of rates-strategy at Commerzbank, does not see a connection with the record sum of spare cash.

"The short answer is no," he said in response to a question about rising excess cash being correlated with a slowdown in inflation. "The ECB would even argue that without the flood of liquidity, inflation would be even lower." The latest handout of ultra-cheap loans will only put modest downward pressure on funding rates, according to Goldman Sachs Group Inc. analysts, who estimate a one-basis-point decline in the ECB's ESTR and Eonia for every 500-billion-euro increase in spare cash.

"We continue to think that the front-end of the EUR curve is instead driven mostly by the prospect of a rate cut," wrote strategists including George Cole.

Money markets in that respect are betting that the ECB will lower the deposit rate by 10 basis points from the current record low of minus 0.50 per cent by the end of next year. BLOOMBERG