Thread by @fwred

Today marks the beginning of a new ECB maintenance period, with the Deposit Facility Rate set at -0.50%, its lowest level on record. All eyes on liquidity developments ahead of tomorrow's TLTRO-III allotment. (1/n) ecb.europa.eu/stats/policy_a…

Waiting for the ECB's two-tier system to be implemented on 30 October, the 'cost' of negative rates will increase to €8.8bn on an annual basis, or €5.5-6.0bn net of TLTRO 'subsidy'. Several dynamic factors at play, starting with first TLTRO-III tomorrow. (2/n)

Euro area banks had until today 09:30 to submit their bids for the first TLTRO-III.1 operation. A crucial one in the context of tiering and the distribution of excess reserves (🇮🇹 🇪🇸). Here are the amounts outstanding from previous operations, with some caveats below. (3/n)

But, first, it's beautiful isn't it?
(4/n)

Now back to tomorrow's TLTRO-III. The allotment is more important than usual because of tiering and liquidity redistribution. Here are our estimates of the TLTRO country breakdown. (5/n)

Crucially, we know that banks will repay €32bn early in TLTRO-II, likely to be rolled into TLTRO-III, but we don't know who will. Depending on the split, Italian banks may have €50-65bn left in TLTRO borrowing capacity. (6/n) ecb.europa.eu/mopo/implement…

This is almost double previous estimates of TLTRO capacity, which may lead to an upside surprise in tomorrow's TLTRO-III.1 allotment. Why does a larger-than-expected take-up from peripheral banks matter? Because of tiering! (7/n)

The key swing factor is indeed the difference between the unused exemptions in the ECB's two-tiered system (largely Italy) and the remaining TLTRO capacity. Here's a stylised example of an Italian bank with unused exemptions... (8/n)

... as opposed to the 'normal' situation described in this stylised example for a German bank. (9/n)

By and large, Italian banks with unused exempted reserves are likely to borrow from the ECB (up to -0.50%) to exploit the carry arbitrage opportunity (reserves at 0%). A large TLTRO-III take-up should help ease tensions in money market as rates find a new equilibrium. (10/n)

To recap, for Italian banks (in aggregate):
- unused exempted reserves in the ECB's two-tiered system = €30bn
- remaining TLTRO-III borrowing = €50-65bn
Enough to ease tensions in money markets, although it could take longer (e.g., more rollover into TLTRO-III.2). (/end)