European Banks May Tap ECB for $629 Billion Cash

By Matthew Brockett and Jeff Black - Feb 24, 2012 7:11 PM GMT+0700

Euro-area banks may tap the European Central Bank next week for almost as much three-year cash as they did in December in an operation that could prolong a rally in bond markets.

Financial institutions will ask the ECB for 470 billion euros ($629 billion) in three-year funds for allotment on Feb. 29, the median of 28 estimates in a Bloomberg News survey shows. While that’s less than the record 489 billion euro take-up at the first tender on Dec. 21, it may increase total cash in the system by more than 300 billion euros, said Luca Cazzulani, a senior fixed-income strategist at UniCredit SpA (UCG) in Milan.

“Part of the increase will likely be parked, at least temporarily, in the sovereign-bond market and support mainly the performance of Italian and Spanish bonds,” said Cazzulani. Still, “expectations are at a pretty high level, which creates some room for disappointment,” he said. “Gross demand below 400 billion euros would likely put upward pressure on spreads in the short term.”

Italian and Spanish bonds have risen since the ECB’s first three-year loan, suggesting banks are investing at least some of the money in higher yielding assets. That’s helped ease concern about a credit crunch and won governments time to agree on measures to contain the sovereign debt crisis.

‘Lose-Lose’ Air

The yield on Spain’s two-year bond has dropped to 2.62 percent from 3.88 percent since Dec. 21 and the rate on a similar Italian bond has fallen to 2.87 percent from 5.14 percent. The extra yield investors demand to hold two-year Italian notes over German debt has fallen to 263 basis points from 492 points on Dec 22. That spread was 720 points on Nov. 25, a euro-era high.

The risk is that banks become too reliant on ECB money and fail to take the steps needed to strengthen their balance sheets.

“There is a ‘lose-lose’ air around the ECB’s auction next week,” said Simon Smith, chief economist at foreign-exchange broker FXPro Group Ltd. in London. “If take-up is low then markets are likely to be disappointed. If take-up is high, then although this may give markets a boost, the bigger picture is of markets becoming increasingly reliant on the ever-expanding good nature of central banks. All well and good, but the routes to the exit are that much longer as a result.”

The three-year funds cost the average of the ECB’s benchmark interest rate, currently at a record-low 1 percent, over the period of the loans and banks have the option of repaying them after a year. Forecasts in the Bloomberg survey range from 300 billion euros to 750 billion euros. No further three-year operations are currently scheduled beyond next week.

Stronger Euro

The euro strengthened against the dollar today, rising above $1.34 for the first time since Dec. 9. The 17-nation common currency gained 0.3 percent to $1.3409 at 12:31 p.m. in Brussels. The Stoxx Europe 600 Index (SXXP) was up 0.3 percent to 264.93.

With the economy set to recover “gradually” this year, there are no signs of downside inflation risks that might justify cutting rates to zero, Executive Board member Benoit Coeure said in a speech published by the ECB today.

In Asia, Vietnam is making headway against the region’s fastest inflation as prices rise the least in 11 months, giving the central bank scope to lower rates. Consumer prices climbed 16.44 percent in February from a year earlier, the General Statistics Office said in Hanoi today.

U.S. Recovery

In the U.S., purchases of new homes probably rose in January to a nine-month high, more evidence the housing market is improving, economists said before a report today.

The ECB’s second offering of three-year loans is intended to relieve liquidity strains in the region as officials work to contain fallout from the debt crisis. The central bank has increased the pool of collateral that banks can use to obtain the loans.

Before the December operation, the ECB reduced the rating threshold for certain asset-backed securities. This month, it said seven of the 17 national central banks in the euro area will also accept credit claims, a move that ECB President Mario Draghi estimates will increase the collateral pool by another 200 billion euros. The aim is to give small and medium-sized banks greater access to ECB cash.

While the overall amount allotted next week may be lower than in the first operation, new borrowing should be higher, said Christel Aranda-Hassel, director of European economics at Credit Suisse in London.

New Money

That’s because banks are likely to roll only about 100 billion euros of existing ECB loans into the three-year facility, with the remainder representing new cash.

In the December operation, about 296 billion euros of the 489 billion-euro total was accounted for by old loans, meaning about 193 billion euros was new money, according to Barclays Capital.

The size of the loans prompted German ECB council member Jens Weidmann to warn that the central bank mustn’t “lose sight of its mandate” to control inflation by taking on “excessive risks.”

Those concerns are likely to see the ECB wind down its long-term lending after the second three-year operation, said Deutsche Bank chief economist Thomas Mayer.

ECB council member Ewald Nowotny said today officials will “wait to see the effects” of the loans. “I personally don’t see any further need for action,” he said.

To contact the reporters on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg.net; Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net