They know: the Eurozone would plunge into a sovereign debt crisis all over again, only worse this time.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

These days it’s easy to tell when general elections are approaching in Germany: members of the ruling government begin bewailing, in perfect unison, the ECB’s ultra-loose monetary policy. Leading the charge this time was Finance Minister Wolfgang Schaeuble, who on Tuesday urged the ECB to change its policy “in a timely manner”, warning that very low interest rates had caused problems in “some parts of the world.”

Werner Bahlsen, the head of the economic council of Merkel’s CDU conservatives, was next to take the baton. “The ongoing purchase of government bonds has already cost the European project a great deal of credibility and has damaged it,” he said. “The ECB can only regain trust with the return to a sound monetary policy.”

As Schaeuble and Balhsen well know, that is not likely to occur any time soon. Indeed, like all other Eurozone finance ministers, Schaeuble is benefiting handsomely from the record-low borrowing costs made possible by the ECB’s negative interest rate policy. But by attacking ECB policy he and his peers can make it seem that they take voters’ concerns about low interest rates seriously, while knowing perfectly well that the things they say have very little effect on what the ECB actually does.

In short, they are telling their voters what they want to hear. A survey by the CDU’s economic council showed that less than a quarter of its roughly 12,000 members had confidence in the ECB’s current course. 76% said they backed Bundesbank head Jens Weidmann’s monetary policy stance. Herr Weidmann said on Thursday that the ECB is at risk of coming under political pressure because any hint of policy tightening could push yields higher and blow a hole in national budgets.

It’s a probably a bit late in proceedings for such worries, what with the ECB now boasting the largest balance sheet of any central bank on Planet Earth. At last count, it had €4.22 trillion ($4.73 trillion) in assets, which equates to 39% of Eurozone GDP. Many of those assets are sovereign bonds of Eurozone economies like Italy, Spain and Portugal.

 

The ECB’s binge-buying of sovereign and corporate bonds has spawned a mass culture of financial dependence across Europe. In the case of Italy, the sheer scale of the government’s dependence on the ECB for cheap funding is staggering: since 2008, 88% of government debt net issuance has been acquired by the ECB and Italian Banks. At current government debt net issuance rates and announced QE levels, the ECB will have been responsible for financing 100% of Italy’s deficits from 2014 to 2019.

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It’s not just governments that are dependent on the ECB’s largesse: so, too, are the banks. In total, European banks have approximately €760 billion of funding from long-term lending schemes, the bulk of which comes from the four rounds of the most recent program launched in March 2016.

As of the end of April 2017, Italian banks were holding just over €250 billion of the total long-term loans — almost a third of the total. Spain had €173 billion, while French banks had €115 billion and German lenders €95 billion. As the FT reports, the funding appears to play much less of a role in stimulating economic activity through lending, and a much larger role in mitigating the pain that low interest rates — and poor asset quality — can inflict on banks.

In its latest TLTRO issuance in March this year, the ECB, in its most generous stimulus yet, pumped well over €200 billion into the European banking sector, with an interest rate of 0% that could fall into the negative, as low as -0.4%, depending on lending activity. Such interest free (or perhaps even interest generating) long-term funding has allowed southern European banks to benefit from carry-trade gains on domestic government bonds. Yet even with this free funding, some of the Italian banks are still unprofitable, says Christian Scarafia, co-head of Western European Banks at Fitch.

While large banks regularly draw on the funding, the biggest beneficiaries of the ECB’s LTRO programs have been smaller peripheral banks, reports the FT. It is they who are likely to be hardest hit by the eventual withdrawal of the subsidies involved. — especially for those smaller banks less able to fund themselves through wholesale markets.

Since reducing the rate of bond purchases to €60 billion a month, the ECB has shown little appetite for reducing it further, for an obvious reason: if it leaves the market, there will be no one left around to buy peripheral bonds in the same volume. The inevitable result will be soaring yields on government debt for countries like Italy, Spain and Portugal.

Germany’s government is perfectly aware of this fact. But the charade of concern and principled opposition to the ECB’s ultra-loose monetary policy must go on, if nothing else but to convince voters to award it another term in office in September’s elections.

In the longer term, Merkel and Schaeuble would like nothing more than to see Bundesbank President Jens Weidmann replace Mario Draghi to become the fourth guardian of the single currency. But Draghi’s term isn’t scheduled to end until October 2019 and a hell of a lot can happen in the meantime. By Don Quijones.

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