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ECB tender could ease credit crunch fears

Frankfurt - The European Central Bank’s (ECB's) first-ever offer of three-year loans is expected to draw high demand from banks on Wednesday, easing fears of an impending credit crunch and possibly bolstering bond and money markets.

The ECB has said the economy could tip into recession if banks do not lend to firms and private consumers, and that it would do everything it can to avoid a liquidity squeeze.

It hopes the limit free, ultra cheap, long funding will boost trust in banks, free up money markets and tempt banks to buy Italian and Spanish debt.

The ECB will release the results of the tender at 10:15 GMT.

Traders polled by Reuters just hours before the operation expected the ECB to allot €310bn, up from a forecast of €250bn in a poll on Monday.

“I expect massive demand from all major European banks. I am convinced that liquidity should support the real economy and thus avoid a credit crunch,” UniCredit chief executive Federico Ghizzoni told Italy’s Radio 24 on Wednesday.

There are increasing signs the takeup will be strong.

More than 10 Italian banks are looking to apply for the new loans, a source told Reuters.

Banks cut their weekly intake of ECB funding on Tuesday, a hint they are saving firepower for the three-year operation.

They also took in €142bn in new one-day loans, introduced to bridge the gap with an expiring one-week tender for those preparing to take the new ultra long funds.

Some €140bn in three-month money will also expire on Thursday, when the three-year funds will be delivered, freeing up additional collateral for banks wanting long-term cash.

But whether banks will use the money to buy Italian and Spanish government debt, as French President Nicolas Sarkozy has urged, is much more open to debate given the competing pressures on them to cut risk and rebuild capital.

“This so-called Sarkozy trade where banks use the money they borrow from the ECB to buy sovereign bonds is wishful thinking quite frankly,” said Tobias Blattner, a former ECB economist now at Daiwa Securities.

Catalyst

The range of forecasts in the latest Reuters poll, €150bn to €550bn, shows there is still much uncertainty.

Analysts say take-up above €350bn would be a positive sign for strained countries and a potential catalyst for some thawing of the frozen money market, whereas a low amount would increase money and bond market jitters.

Tuesday’s liquidity operations as well as a halving of Spain’s short-term financing costs show that the ECB’s newest tools to repair money markets are already having an impact and have lifted expectations for high demand for the three-year money.

The three-year funds will be offered at an interest rate indexed to the ECB’s main refinancing rate over the life of the loan. That rate is, after a rate cut earlier this month, at a record low of 1.0%.

For some banks the money could be more than 3 percentage points cheaper than they can get on the open market. As part of the deal they can switch money borrowed from the ECB back in October into three-year funding and will also be able to pay it back after just a year if they so wish.

Another factor boosting demand is that banks are now more reliant than ever on central bank funds. The ECB on Monday said, in its semi-annual Financial Stability Review, that this dependency could be difficult to cure.

French banks have almost quadrupled their intake of ECB money since June to €150bn, while banks in Italy and Spain are each taking more than €100bn.

ECB president Mario Draghi has been pressing banks to take the money since announcing the plans earlier this month.

He warned of a chance of a credit crunch on Monday, and said that eurozone bond market pressure could rise to unprecedented levels early next year.
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