TLTRO III funds: when is the best moment to knock at the ECB door?

In September 2019, the ECB announced changes to the new targeted longer-term refinancing operations (TLTRO III). Differently from what outlined in March, the maturity of TLTRO III operations was extended from two to three years, and, for the banks exceeding their lending benchmark, the interest rate applied will be the average interest rate on the deposit facility without the 10-basis point spread. These changes make these operations more appealing.

Nevertheless, the fact that interest rates on the new funds can now vary over the life of the TLTRO III operation, and are not fixed at the time of allotment as for the previous LTRO, generates uncertainty on the overall gain for a bank.

For instance, let’s assume a banks requests 50 billion euros and that the interest rates on the deposit facility are as forcasted in latest Outlook on the Banking Sector.  If these funds are taken in December 2019, the total benefit over the three years will be about 700 million. Instead, if the same funds request were made in March 2021, the last available auction, the overall benefit would be almost halved, as we forecast a rise in interest rates in 2022 (Fig 1).

The reason why we keep interest rates fixed at the current level until mid-2022 is that we assume in increase in government spending in the Euroa Area countries with fiscal space to do it. This has a positive effect on growth and inflation, making a further reduction in interest rates unnecessary. The criticism,  within and outside the ECB, aroused by Mario Draghi's latest package of measures - in particular the restart of Quantitative Easing - might also make further loosening of monetary policy more difficult.

But the ECB has not ruled out the possibility of additional cuts of interest rates: since inflation is still well below the target and several forecasts, including those coming from the Euro Tower itself, indicate that it should increase only starting from 2021, and, in any case, to a level still “far” from 2%. At the end of September, a Reuters survey of market analysts was still showing expectations for a further cut in deposit rates. 

Under the current conditions, therefore, postponing the request of TLTRO III funds is also a bet on future path of short-term interest rates.