ECB struggling to meet balance sheet target

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Stones balancing on eachother

Again, international financial markets saw turbulence in the past week. The main cause was deep concern about Greece and China, as well as doubts on whether the European Central Bank (ECB) will be able to jumpstart Europe's economy. Capital market rates in key countries declined once more.

A more extended toolbox, including a sovereign bond purchasing programme, seems to be the only viable option left. Ben Steinebach Ben Steinebach Head of Investment Strategy

Thursday, European banks took up EUR 129.8 billion in the ECB’s second tranche of TLTROs (targeted longer term refinancing operations, providing cheap loans to banks that may not be used to purchase bonds or to finance mortgages). As markets had expected a take-up of about EUR 150 billion, the actual sum was rather disappointing.

The ECB is aiming to extend its balance sheet by EURO 1000 billion in total, but that will be difficult to pull off, all the more so since some EURO 270 billion worth of 3-year LTROs from 2011 are about to expire. Add to this the meagre EUR 82.6 billion take-up from the first tranche, and it becomes clear that the take-up to date is not even enough to make up for redemptions. Meanwhile, the ECB is trying hard to reach its target by means of a purchasing programme for corporate and asset-backed bonds. However, Europe's markets for such paper are too small to support this initiative.

A more extended toolbox, including a sovereign bond purchasing programme, seems to be the only viable option left. Although this will lead to mounting tensions within the ECB, where the Germans are utterly opposed, we are expecting such a move to be announced in January. These circumstances will undoubtedly put further pressure on Europe's core country capital market interest rates. We already had a taste of this in the past week. In Germany, 10-year bond yields lost 10 base points to end up at 0.68%, partially due to the steadily declining oil prices and related strained inflation expectations.

On the other hand, interest rates in Southern European countries edged upwards again as a result of Italy's credit rating downgrade and unrest in Greece. Presidential elections in Greece have been brought forward to 17 December, and may involve two more voting rounds after that. A new president must be appointed by the 29th of December, backed by at least 180 out of 300 parliament members, failing which general parliamentary elections will have to be called.

Investors are worried such elections may be won by Syriza, a eurosceptic party which is unwilling to meet the demands of the Troika (IMF, ECB and European Commission). This has prompted media speculation in the past week about a return of the euro crisis. We think it is still too early for that. Even in the unlikely event of parliamentary elections being held and Syriza emerging the victor, that party would ultimately have to compromise to prevent Greece from being cut off from international credit lines.

Equity markets correct due to worries about Greece

Despite positive macro-economic data, last Friday's upbeat mood could not be sustained. Investors grew nervous and equity markets fell due to concerns about Greece and the questionable quality of Chinese banks.. Last week the central bank of China announced a purchasing programme for short-term, high-quality government bonds. The idea is for Chinese banks to use the money from the sale of bonds to clean up their balance sheets. T

his move has led to instant speculation that Chinese banks may be undercapitalised and therefore in bad shape. Along with the alarm about political developments in Greece, these fears triggered price falls on international equity markets, which only last Friday had reached new highs. Thursday’s losses on US stock exchanges totalled 1.5% to 2%, and even more in Europe and Japan. European stock performance was varied, however.

Declines of over 4% on average were seen in the United Kingdom, France and Spain, but German stocks fell by just 2.25% . In Germany, encouraging data was released on industrial production and industrial orders, dispelling the gloomy sentiment towards German industry in September and October, which was caused by an unfortunate combination of events in August. The AEX index’s 3.3% decline was average.

KPN announced new restructuring this week, which will result in 580 jobs being cut. A new provision of EUR 50 million will be made, but after 2016 the restructuring is expected to yield EUR 45 million a year. The programme was motivated largely by changes that are occurring on the business market. On Thursday markets picked up again somewhat, mainly in the United States, which was due in part to the release of positive macro data. November retail sales in the United States were 0.7% up from October, which lifted year-on-year growth from 4.5% to 5.1%. This was a pleasant surprise and bodes well for Christmas sales, which are by now well under way. Europe's markets remained depressed on Friday morning.

Continued lack of corporate news

As before, in the upcoming week financial markets will have to make do with macro-economic newsflow. Anticipated highlights include confidence indices relating to both consumers and manufacturers in many countries. Germany will be one of the sources of manufacturer confidence data, as next week the key Ifo index will be published, as well as, the ZEW index, detailing how investors feel about investment opportunities in Germany and Europe for December. Both indicators showed mild recovery in November.

Meanwhile, the United States will issue the Philadelphia Fed index, an initial indication of business confidence for the greater Philadelphia region, which also doubles as a reasonable benchmark for the US economy as a whole. For December's consumer confidence we turn to Germany, Belgium and the Netherlands in the upcoming week. The United States will publish new data on industrial production in November, and the United Kingdom and the Netherlands will follow up on retail sales in October.

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