Thursday, 1 March 2012

Abracadabra

Courtesy of Darren Wyn Rees: Statue of Tommy Cooper in Caerphilly Town Centre  
“Glass, bottle. Bottle, glass” was the refrain of the iconic comedian Tommy Cooper as he produced a series of bottles out of thin air. I was reminded of this after the announcement from the European Central Bank (ECB) that a further €500 billion or so was being lent to the banking system as part of their ongoing Long Term Refinancing Operation (LTRO). €500 billion here, €500 billion there - pretty soon, you are talking about a lot of money. So what is going on?

Essentially the ECB are making funds available to banks to cover their funding requirements over the next three years and to try to ensure that lending within the EU remains supported. However, there are two sides to the equation, in that there needs to be demand for loans as well as supply, and with the current economic uncertainty coupled with the relatively robust health of corporate balance sheets, demand for loans remains subdued. This adds to the downward pressure on money supply which, in turn, has knock on effects on economic growth and inflation. Meanwhile, banks’ balance sheets, stretched to breaking point by the problems in the peripheral eurozone, are given an infusion of cash and, as importantly, the time to continue to rebuild and dispose of non-core assets. As a sign that Mario Draghi is taking extreme measures to tackle the situation in Europe it is to be welcomed, although it remains to be seen precisely what the long term effects will be. Ultimately, it is the creation of a further €1 trillion euros or so which will go some way to counteracting the deflationary effects of austerity measures and create, essentially, a negative interest rate environment. And in the words of another famous magician “That’s magic!”

ROB BURGEMAN

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