European Central Bank to create 500bn euros for banks to guzzle

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European Central Bank will create another half a trillion euros of cheap three-year loans, to be offered to banks in what is being called as the last of its kind opportunity, according to a Reuters poll of money market traders.

The Reuters poll of 30 euro money market traders suggested the ECB will allot €500 billion ($672.31 billion) at this week’s longer term refinancing operation (LTRO), with forecasts ranging from 200 billion to €750 billion.

Money supply data suggested on Monday that the initial December allotment of €489 billion of three-year loans eased state borrowing costs for Italy and Spain while helped avert a euro zone credit crunch in January.

Critics have raised their concerns about the impact of too much cheap money within the system, and ECB Governing Council member Ewald Nowotny demanded the bank to gauge the impact of the double-dose of ultra-cheap funding before taking any more steps.

Traders also confirmed that Wednesday would be the last chance for banks to grab cheap loans from the ECB with such long maturities.

“Banks are all looking to buy time,” said a money market trader told Reuters.

“There is still too much liquidity in the system, but it is (of) a long tenure and it might be the case that some of the big names are looking for the long-tenure cash,” he added on condition of anonymity.

Borrowing costs have fallen in Italy and Spain since the first LTRO which was held in December last year. Both eurozone nations moved into the spotlight of the debt crisis last year soon after Greece, Ireland and Portugal defaulted on their loans and had to be rescued by multi-billion eurozone bailout packages. Parts of the interbank lending market have reopened and stock markets have rallied since the LTRO mechanism was introduced by the ECB late last year.

Euro-priced bank-to-bank lending rates fell below the European Central Bank’s benchmark lending rate of 1 percent on Monday in anticipation of Wednesday’s operation.

The ECB’s money has become less attractive than it was at the time of the first 3-year injection due to the excess liquidity in the system that has pushed bank-to-bank lending rates down by a third since December.

AGGRESSIVE BUYS

ECB officials are hoping they will use the second round more aggressively to buy higher-yielding bonds if banks, especially from Italy, used the first LTRO to plug their funding needs and fend off a credit crunch. Financial analysts insist Europe can ill afford to bail out the fourth largest European economy.

Data on Monday showed the monthly rise in the value of Italian banks’ government debt holdings registered a record monthly rise to reach €280 billion from €20.6 billion a month.

Italy met solid demand ahead of the latest ECB cash offer as its six-month borrowing costs sank towards 1% at auction and sold €12.25 billion in short-term bills on Monday.

“I suspect this is market positioning in anticipation of a relatively significant LTRO take-up, the proceeds of which will then be parked in the front end of the Italian curve,” said Richard McGuire, a strategist at The Netherlands-based Rabobank.

Anecdotal evidence suggests banks in Spain used the first LTRO to make most use of this “Sarkozy trade” – a term adopted by markets after French President Nicolas Sarkozy suggested governments look to banks that tapped the ECB operation to buy their bonds.

Italy needs to sell around €45 billion euros of its bonds a month in both March and April versus €19 billion in February or face a debt issuance hump in the next few months. Some financial analysts are hinting Rome could do with the second LTRO fuelling demand for its debt.

However, the use of LTROs has been met with some controversy in northern euro zone states, particularly Germany.

“The LTRO is in principal nothing less than a bailout for southern European states,” Commerzbank (CBKG.DE) CEO Martin Blessing said last week.

“We expect additional demand from some countries due to the extension of collateral requirements and also because it is considered by almost everyone as the last opportunity to get three-year liquidity,” said another euro money market trader.

OFFICIAL BLESSING

ECB President Mario Draghi has urged banks to lend money to households and businesses and aid economic growth in the 17-member common currency bloc borrowed at this week’s tender.

An overwhelming majority, 26 of 29 traders, believe the ECB is not likely to conduct any more liquidity operations with a three-year tenure as the effects of the tenders take time to seep into the system.

In a regular weekly poll, traders expect the ECB to lend €125 billion at its seven-day operation this week, much lower than the €166.5 billion it lent last week, as banks save collateral ammunition for the three-year tender.

(By Moign Khawaja with input from Reuters)

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