The ECB has repeatedly stressed the primacy of its PEPP asset-purchase program in tackling the economic impacts of Covid, despite the importance of the bank-lending channel for the European economy, given the high degree f financial intermediation. The decision taken last week to provide leverage-ratio relief for banks suggests that the ECB’s focus is shifting towards the banking sector. In taking the decision to temporarily exclude specific central bank exposures from the ratio calculation, the Governing Council stressed the “exceptional circumstances” presented by the pandemic.

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When the ECB eased the conditions of TLTRO-III in April much was made of the subsequent €1.3trn take-up at the quarterly allotment in June. However, a large block of the TLTRO was used to repay previous borrowing and buy government debt (reigniting the carry trade, which we have previously highlighted).

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The decision to offer leverage ratio relief will similarly do little to further stimulate bank lending to the economy given the flattening of the term structure (which has eroded bank profitability and reduced the incentive for riskier private sector lending) and heightened uncertainty over the demand outlook.

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However, as furlough schemes and various other subsidies expire, policymakers will need to find a way of putting money in hands in order to support the recovery, rather than reflating the financial economy as happened after the 2008-2009 crisis. With that in mind, the ECB will remain on the hook for further monetary accommodation at some point, with the credit transmission channel increasingly targeted.

Charts Source: Bloomberg, Macrobond and Variant Perception

In the near future this would likely take the form of an adjustment to the tiering multiplier on reserves given the cost associated with a steady build up in excess liquidity. Thereafter, further easing of borrowing conditions (perhaps by easing collateral requirements) and potentially the offer of even longer-dated loans are possible.