Below is a chart by Scott Barber showing how the first LTRO has affected the ECB's balance sheet. As 'only' about € 200 billion of the € 490 billion in this LTRO were additional funds (the remainder were rollovers of a previous LTRO), the balance sheet didn't increase by the full amount allotted. Nevertheless, the rate of growth has visibly accelerated. For the year, the ECB's balance sheet has now grown by 36%. The growth over the last month alone was approximately 100% annualized.
The recent growth in the ECB's balance sheet already exceeds that seen during the 2008 crisis in absolute terms – click chart for better resolution.
Since there has been scant growth in credit inflation initiated by commercial banks over the past 18 months, the sideways move in the ECB's balance sheet over that period coincided with the lowest rate of growth in the euro area's true money supply since the inception of the euro. Year-on-year growth of euro area TMS has recently slightly accelerated from 1.5% to 1.8%, which is the upper end of the range it has seen over the past year or so.
As we have frequently pointed out, it is precisely this slowdown in money supply growth that precipitated the crisis. Since the lagged effects of this slowdown have yet to fully play out, one should expect economic growth to continue to weaken significantly over the next several months, as more and more malinvested capital is liquidated.
However, it should be noted here that the ECB's extraordinary monetary pumping measures after the 2008 crisis were followed shortly by a vast expansion in euro area TMS. Whether the money supply will grow to a similar extent as a result of the recently implemented measures remains to be seen, but we can already say that if the commercial banks decide to play the sovereign debt carry trade, then it will most definitely happen - in spite of a dearth of private sector credit demand.
As we have previously pointed out, there are in fact a number of good arguments that the commercial banks will indeed engage in such carry trades. The most important one is that the banks are anyway condemned to sink or swim with their sovereigns. Furhermore, the EBA (European Banking Authority) has let it be known that falling bond yields would lower the required capital increases demanded by the regulator. Lastly, many banks have depended on their governments in order to get hold of suitable collateral in sufficient amounts to be able to participate in the LTRO – specifically Italy's banks have issued bonds that have been garnished with government guarantees to meet the ECB's collateral eligibility standards.
It would be rather strange if there were no quid pro quo agreements struck sub rosa in the course of all this wheeling and dealing. In fact, the success of Italy's large bill and bond auctions this week and Spain's auctions in the prior week argue strongly in favor of this contention.