ECB expiry hits euro

IT IS crunch time for the European Central Bank (ECB) and the single currency this week. As of tomorrow, Eurozone banks will no longer be able to tap the central bank for unlimited long-term loans. It has already indicated that it will not renew its €442bn 12-month long-term refinancing operation (LTRO) and is likely to only roll over the funding for three months.

This is in spite of persistent fears about Eurozone banks’ funding capabilities and when there is still significant demand for liquidity. The Bank for International Settlements (BIS) warned earlier this week that losses on European bank balance sheets are expected to climb.

A lack of money on offer from the ECB will make it harder for banks to meet their funding needs in the market. This is bad for the euro, which reached its lowest level in 19 months against the pound yesterday.

A dearth of liquidity in the markets is not good news for the euro and FX traders should be closely watching today’s three-month LTRO. “The expiry is going to trigger demand for shorter-term funding and so the take-up of today’s three-month LTRO will be important,” says RBS’s Melinda Burgess. RBS expects the uptake to be hefty, at around €250bn. “Such a sizeable uptake would imply that there is still significant funding stress within the Eurozone, or more specifically at the periphery of the region,” she explains.

Alastair Cotton at Currencies Direct agrees, saying: “Any bank participating in the auction will show it has trouble in tapping the market for funds and the uncertainty over which banks this might be is feeding through to euro weakness.”

The sovereign debt crisis and its impact on the banks was always going to undermine the euro, it appears that the downside risks have increased earlier than expected, says BNP Paribas’ Ian Stannard. The key level to look for is euro-dollar support at $1.2160 – “a close below this level opens the way for another wave of aggressive euro selling”. The euro was hovering at the $1.22 level yesterday, so it might well be time to add to those euro shorts.