Like an elixir discovered by an alchemist, the three-year longer-term refinancing operations have produced eye-catching results for Mr Draghi. The first, in December, saw the ECB providing €489 billion and marked a turning point for the eurozone. At the time, financial market tensions meant Europe’s monetary union was perilously close to a banking catastrophe. But the three-year LTRO bought time by soothing financial market nerves and boosting economic confidence.
The risk, however, is that too high a sum will shift Mr Draghi’s reputation from the central banker who conjured up breathing space for the eurozone to the central banker who simply spoilt the bankers.
The three-year LTROs were gauged to match banks’ funding requirements and prevent a credit crunch, triggering a deep recession. They have become continental Europe’s answer to “quantitative easing”, operating via banking channels rather than asset purchases. But if demand this week hit for example €1 trillion, the suspicion would be that banks were tapping funds primarily for lucrative carry trades – borrowing at 1 per cent from the ECB to invest in higher yielding instruments.
At stake could be Mr Draghi’s relationship with Germany’s conservative Bundesbank. Bundesbank president, Jens Weidmann, went along with the LTRO programme but voiced concern at the generosity of the ECB’s terms. His fear is not just of giving banks the wrong incentives but that they have become dependent on the ECB’s munificence, reducing the chances of financial markets returning to normal. Banks using ECB funds to buy sovereign bonds could be seen as indirect central bank funding of governments – a sin in the Bundesbank’s eyes.
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