European Rates Watch: Three scenarios for 2020

BofA| We present three scenarios for the ECB’s balance sheet in 2020 based on TLTROs and APP projections. At the top end, we estimate the ECB’s balance sheet to reach a record high; at the bottom end, we estimate a small decline. Banks’ interest in TLTRO III would be crucial in determining the actual outcome.

In our view, there are two main determinants of the ECB’s balance sheet in 2020. The first determinant is the net change in targeted long-term financing operations (TLTROs). The second determinant is the open-ended asset purchase programme (APP). At the top end, we estimate the ECB’s balance sheet could exceed EUR 5,000bn, which would bring it to a record high. At the bottom end, we estimate the ECB’s balance sheet could decline by just EUR 63bn. The relative support to the ECB’s balance sheet size is provided by expected net purchases under the APP.

Scenario 1: TLTRO II not rolled over + no TLTRO III take-up = EUR 63bn decline

Scenario 1 creates the bottom end of our scenario analysis: TLTRO II.1, TLTRO II.2, and TLTRO II.3 mature in 2020 and are not rolled over, which reduces TLTRO outstanding by EUR 303bn. The EUR 303bn decline in the ECB’s balance sheet from TLTROs would be partly offset by the EUR 240bn increase from APP purchases, causing a net EUR 63bn decline in the ECB’s balance sheet to EUR 4,629bn by the end of 2020.

But banks did take up some funds in the first two TLTRO III operations conducted in 2019. Therefore scenario 1 represents our estimated lower bound for the ECB’s balance sheet in 2020.

Scenario 2: Net TLTRO outstanding unchanged = EUR 240bn increase

Scenario 2 is based on banks rolling their outstanding TLTRO II into TLTRO III in 2020 to keep their outstanding TLTRO borrowings unchanged. In this scenario, we estimate the ECB balance sheet would increase by EUR 240bn to EUR 4,932bn, driven purely by the APP.

The path of the ECB balance sheet size under this scenario could be volatile because the maturity of TLTRO II is uneven. Of the EUR 303bn TLTRO II maturing in 2020, EUR 223bn will mature in June 2020. It is uncertain whether banks would or can roll over this amount in the June 2020 TLTRO III operation alone.

Scenario 3: LTROs rises back to recent highs = EUR 360bn increase

Scenario 3 is based on banks raising their TLTRO borrowings so that LTROs rise back to their recent June 2017 high. This would require a net borrowing of EUR 150bn via the remaining five TLTRO III operations, four of which are in 2020 and a final one in 1Q 2021. We assume the net borrowing would be evenly spread across the remaining TLTRO III operations, which imply a net increase in TLTRO borrowing of EUR 120bn in 2020. Accounting for the EUR 240bn net APP purchases, we estimate the ECB’s balance sheet could increase by EUR 360bn to a record high of EUR 5,052bn.

Implications

The downside to the ECB’s balance sheet size in 2020 is limited by its EUR 240bn net purchases from the APP.

Banks’ interest in TLTRO III would be crucial in determining the actual outcome. We stress the three scenarios presented do not represent discrete outcomes. For example, if banks partially rollover their TLTRO IIs into TLTRO IIIs, then the actual outcome could be between Scenario 1 and Scenario 2. Conversely, if the outlook improves and/or tiering terms improve, banks could be inclined to grow their balance sheets and borrow more than we envisaged in Scenario 3.