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    New Euro injection

    Fatih Özatay, PhD01 March 2012 - Okunma Sayısı: 1037

    Huge injections by the ECB do not eliminate the fundamental problems of Europe. Yet, it is not the ECB’s duty to solve Europe’s problems.

    On December 21, European Central Bank (ECB) lent banks 489 billion Euros for three years at the average of benchmark interest rate, which currently is 1 percent. With a second auction held yesterday, the ECB awarded another 530 billion Euros to banks. This also is a three-year loan at the average of benchmark interest rate. It is said that in the first auction, 523 banks were financed and the number is estimated to rise to 800 with the last auction.

    Following the first attempt, a substantial increase in risk appetite was observed across international financial markets. Then, the Federal Reserve (FED) announced that the current interest rate policy is to be maintained until 2014. Also, the FED signaled that a new quantitative easing can be introduced if deemed necessary. As a result, risk appetite increased further. Despite the temporary drop in the appetite due to the developments about Greece, financial markets are in a positive mood since the end of December.

    Unrealistic estimations were made about the amount to be lent via the latest auctions. The estimations normalized in time. The latest polls before the auction revealed an expectation for 500 billion Euros, which matched the actual amount lent. If the amount was significantly above 500 billion Euros, it would imply that the problems of banks have re-escalated and tension would elevate among financial markets. This would in turn squeeze the risk appetite. Fortunately, this was not the case.

    Still, it is evident that such huge injections do not eliminate the fundamental problems of Europe. Yet, it is not the ECB’s duty to solve Europe’s problems. Indeed, the Bank does not have relevant tools. What the ECB does is to save time for European leaders to take action. With the injections, it solved the liquidity problems of European banks which had peaked by the end of 2011, giving banks a sigh of relief.

    What might be the repercussions for Turkey? Our experiences since December give a critical insight: as the risk appetite picked up, foreign fund inflows to Turkey increased significantly. Value of the Lira tended upwards and this trend is expected to continue unless a new turmoil breaks out. This can relieve the Central Bank of Turkey. Lately, price of crude oil started to move up. Any downwards pressure on exchange rate can offset the adverse effect of oil prices on inflation. Moreover, it can lower the chances for growth below the official estimate at 4 percent.

    What could disturb the positive mood? There are a number of possibilities, all of which are about European countries, including Portugal, Spain, Ireland and Italy. Negative developments are probable in any of these countries. You can easily guess the implications of negative developments in Europe, as we have witnessed such during 2011. But I think the damage will be the harshest if it becomes clear that Greece will eventually have to leave the Eurozone.

    Another element that could disturb the positive mood, though it will not be as strong as Greece leaving the Euro, is that the financial bailout fund of Europe will terminate in July. The fund will then be replaced by the permanent bailout mechanism. The new fund will have a capital amounting 500 billion Euros. It is a long discussed issue that this amount is insufficient. It is proposed to combine it with the remaining 200 billion Euros of the temporary fund. Germany opposes to this option. On the other hand, China, Japan and the US are called for stepping up so as to contribute to the fund and to increase the lending opportunities of the IMF, or at least to do the latter. During the G-20 meeting, US Secretary of Treasury called Europe for doing its homework, that is, raising the bailout fund capital sufficiently. It appears that financial markets will monitor the discussions on the basis of the bailout fund closely.

    This commentary was published in Radikal daily on 01.03.2012