Looking at the crucial meeting of the ECB the banks

By Leonidas Stergiou

Greek banks hold government bonds worth 30 billion euros, which correspond to 46% of their assets. In fact, 69% of these relate to Greek government bonds, the yields of which increase after August, ie after the concerns about inflation and the reduction of the extraordinary bond purchase program (PEPP) by the ECB.

The Governing Council of the ECB, which is meeting and will make announcements tomorrow on PEPP and inflation, is looking for a solution that will send a clear message to the markets about intentions, while keeping the political balance between of its members.

There are two key questions that need to be answered:

First, the management of inflation and pressures coming mainly from Germany for immediate intervention, with the first step the end or the significant reduction of PEPP.

Secondly, the communication of the intentions for the PEPP and the other liquidity mechanisms of the ECB, after the end of the emergency program in March.

According to sources in Frankfurt, the ECB will maintain the view that inflation, although it seems to last longer than expected, remains a temporary phenomenon and as such should be addressed. In fact, the information states that it will present estimates for inflation until 2024, where it will show it below 2%.

The characterization of inflation as a transient phenomenon will be key to the ECB ‘s intentions, as it has previously stated that the PEPP will continue as long as inflation is transient. This, in fact, is mentioned in the Financial Stability report of the BoG.

However, the official end of the PEPP associated with pandemic control in Germany is March 2022. Suggestions for postponing critical inflation decisions and PEPP are unlikely to be accepted, as the ECB believes this will be taken as weakness, a few months before the end of PEPP.

Thus, markets and banks are turning their attention to the ECB announcement tomorrow and especially to the wording and words to be used. One of the scenarios, which is considered the most likely as it satisfies all parties is predicting the maintenance of PEPP until March, with possibly limited markets. At the same time, an increase is expected, up to doubling the traditional APP bond market program after March, but also a continuation of QE. In the last two, however, Greek bonds are not acceptable, as they do not have an investment grade.

And in this matter, the market is waiting for an answer tomorrow, as the postponement can give food for speculation and the uncertainty to boost the yields of Greek bonds. Thus, along with the reduction of PEPP, which satisfies the voices pushing for measures against inflation, the ECB is expected to open its papers for the fate of Greek bonds after March.

The scenarios

The scenarios that have fallen on the table provide the following solutions:

First, to provide flexibility in refinancing the securities of expiring Greek banks and to maintain liquidity holding long after the end of the PEPP. This practically means that if a bond matures after March, it can be replaced with a new one. Also, Greek banks will be able to maintain liquidity through PEPP for a long time after March, exchanging securities for money, gradually, depending on their needs. It is recalled that the ECB through PEPP has bought Greek bonds of 30 billion euros and is expected by March 2022 to have reached this amount of 40 billion euros.

Secondly, there should be some exception and flexibility in the eligibility of bonds, such as those in Greece that do not have an investment grade rating for ECB bond purchase programs. This scenario, according to information, is being discussed but clashes with legal and political reactions. However, it remains on the table.

Greek banks

According to market analysts and bank executives, the Greek banking system has great liquidity and will not face any problems with the decisions on PEPP. It is indicative of the fact that during the PEPP, from the beginning of the pandemic until today, Greek banks use the repos tool more for their liquidity, while they proceeded to raise capital of 7 billion euros from the markets.

Uncertainty, however, is what puts pressure on bond yields and, consequently, falling prices, with particular emphasis on inflation concerns. It is indicative that from August onwards, ie after the concerns about the reduction of PEPP and inflation, the yields of European bonds began to increase. The upward reaction of Greek bonds was more intense.

The increase is evident in the yields in all maturities, while in the 5-year, 10-year and 30-year bonds, their price has fallen below the nominal value of 100 points. Indicatively, the yield of the ten-year Greek bond, from 0.59% in August, today is close to 1.33%, with the price having fallen from 101.57 points to 94.69 points, ie a decrease of 6.88 base units.

These bond movements are important for Greek banks due to the large exposure to government bonds and portfolio valuations. Falling yields boosted their prices, causing them to record profits. The reverse course can create pressures, although this depends on many technical factors, such as the composition of the portfolios and the valuations at current values. For example, according to data from the first half of 2021, the total exposure of Greek banks in bonds was 29.2 billion euros, but the corresponding in current values ​​was only 8.5 billion euros, which was lower than in the first quarter. (8.8 billion euros).

However, the Financial Stability Report of the Bank of Greece states that there was an increase in the interconnection of the banking system with the state, as it stood in June 2021 at 26.3% as a percentage of total assets (21.4% in December 2020) and in 44.8% as a percentage of GDP (36.5% in December 2020). According to the BoG, in 2021, there was a de-escalation in the yield of 10-year Greek bonds, with the lowest yield of 0.55% being recorded on August 9, before the concern that the ECB may restrict markets under the PEPP. Respectively, the yields on the 10-year Eurozone bonds increased during the period between August and the end of September, with the result that the yield on the Greek 10-year bond increased to 0.88% on September 30, while the spread against the corresponding German bond decreased from 115 basis points on March 31 to 108 basis points on September 30 due to the larger increase in the yield of the German bond compared to the Greek. Nevertheless, the BoG notes, the Eurosystem’s purchasing programs continue to keep eurozone government bond yields low, while maintaining favorable economic conditions.

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