With a 0.5% subsidy, TLTRO has been a key measure to mitigate the impact of negative interest rates on bank earnings, so the TLTRO repricing might induce the ECB to amend the terms of the tiering framework to provide relief to banks instead, something the ECB has been hinting at since December as well. The ECB would essentially recalibrate the sources of mitigation from subsidizing liquidity provision to the tiering system, where part of the excess liquidity holdings are exempt from the negative deposit facility rate. The somewhat sudden prospect of raising policy rates, back to 0% in the foreseeable future, might instead suggest an unchanged tiering configuration from here, with the ECB simply abolishing the framework altogether at a 0% deposit facility rate.
In June, the expiry of the subsidy could lead to potentially sizeable early TLTRO repayments. But given the rate applied to TLTRO borrowing post June 2022 features the average deposit facility rate during the entire life of the operation, banks still have an incentive to maintain their TLTRO liquidity, as the borrowing rate would still be lower than the rate applied to central banks deposits in the event of rate hikes.
However large the early repayments eventually are, we believe they will not cause any material tightening in liquidity conditions as long as they are largely limited to the amount of borrowing taken to arbitrage the deposit facility rate, as these funds have been sitting idle at the various national central banks and never circulated in money markets. Therefore, we do not expect either the TLTRO repayments, or any tiering adjustment, to materially impact the euro short-term rate (€STR), as unsecured overnight deposits from non-bank financial institutions should be largely unaffected by a decline in reserves or an increase in the amount of exempt reserves.
Similarly, pressure on Euribor fixings would predominantly result from banks replacing central bank funding with unsecured commercial paper funding. TLTRO repayments will likely free up some collateral though, as government bonds could be taken out of the collateral pool at the national central banks and made available to the broader repo market. Hence we expect some modest cheapening pressure on repo rates on the back of TLTRO repayments, but nothing significant as we also foresee demand for high quality collateral to remain strong.