Eurozone Weekly Economic Briefing: 10 Feb 2012

The ECB's three-year long-term refinancing operation (LTRO) executed at the end of last year has contributed to a significant improvement in financial conditions in the Eurozone. Sovereign yields have fallen, especially in Italy and Spain, bank funding pressures have eased and stock markets have rebounded. There is little doubt that the LTRO has greatly reduced the risk of liquidity-driven bank collapses in the Eurozone a risk that was very real in late 2011. But the LTRO is not a panacea for the Eurozone's woes. It risks tightening the bank-sovereign link in some countries, increasing the systemic risk from pressures on public finances. It also risks making the banking sector dangerously dependent on ECB funding and reducing the flexibility of bank balance sheets. Finally, it is unlikely to prevent a significant tightening of credit conditions in the Eurozone this year that will contribute to recessionary conditions with an inevitable negative feedback into government finances. The LTRO is mostly about crisis management and, if the ECB wishes to stimulate the Eurozone economy, it would be better to do so through a quantitative easing programme.