European economy gets huge cash injection

Mario Draghi, the ECB president, said the last such offering averted a ‘major, major credit crunch’ [GALLO/GETTY]

Banks have bought $713bn in funds from the European Central Bank at the lender’s second offering of cheap three-year funds, raising hopes that more credit will flow into European lending markets and government borrowing costs will begin to ease further.

A total of 800 banks borrowed at the ECB’s latest offering on Wednesday, with demand exceeding the $672bn expected by traders and well above the $657bn allotted in the first such operation, which took place in late December last year.

“This will increase the level of excess liquidity pretty sharply which is ultimately positive or very positive for risk trades,” Luca Cazzulani at UniCredit said. “Italian and Spanish bonds are likely to benefit from this and equity markets as well.”

The euro rose briefly before easing versus the dollar while stocks were little changed immediately after the slightly better-than-expected take-up.

The three-year-loans are the ECB’s latest attempt to fight the eurozone crisis.

Mario Draghi, the president of the bank, termed the first such offering of what are known as long term refinancing operations (LTRO) a measure that had averted “a major, major credit crunch”.

Much of the $657bn that 523 banks had borrowed the first time was used to cover maturing debt. Draghi has urged them to lend out the funds they have tapped at Wednesday’s tender to households and businesses, helping them to strengthen economic growth.

ECB officials are also hoping that banks will use the money to buy higher-yielding bonds, and invest in higher risk sovereign debt, more aggressively.

Spanish banks bought a net $31bn of government debt last month and Italians $27.6bn, both record increases.

Dependency risk

Banks have already taken more funds from the ECB than they had done before, and now risk becoming dependent on such offerings.

Italian banks, for example, had taken more than $268bn in central bank funds by January, and those in Spain and France were not far behind.

Analysts say the LTROs are allowing governments time to work out sustainable budgets and growth targets.

“With the ECB’s supporting measures time is being won,” Michael Kemmer, managing director of Germany’s BdB banking association, said.

“But these measures can neither replace a functioning inter-banking market nor solve the debt crisis.”

Rather than a simple flat rate, the three-year funds were offered at an interest rate averaging the interest rate in its main one-week refinancing operations over the next three years.

That rate is currently at a record low of one per cent. Banks have the option of paying back all or parts of the loans at any time after one year.

It is illegal for the ECB to offer direct support to a government, but these credit infusions to banks allow it to do so indirectly, using the banks as conduits. It does not, however, have any formal say over how the banks invest the money.