ECB Pumps E442 Billion Into Banking System

A serious injection to unlock banking freeze

By Ralph Atkins in Frankfurt, Krishna Guha in Washington and David Oakley in London

Published: June 24 2009 11:05 | Last updated: June 24 2009 23:12

The European Central Bank on Wednesday pumped hundreds of billions of euros in one-year loans into the eurozone’s weakened banking system, making record amounts of emergency finance available in a bid to unlock credit markets and revive the region’s economies.

The move came as the US Federal Reserve pushed back against expectations of an early rise in US interest rates.

In a dramatic step dubbed “stimulus by stealth” in financial markets, the ECB lent €442.2bn for 12 months to more than 1,100 banks at its current benchmark interest rate of 1 per cent.

The high demand for the funds, in what was the ECB’s first ever auction for one-year loans, reflected a growing realisation by the banks that emergency funding may not be available again on such favour-able terms.

The central bank’s action could boost the eurozone’s recovery prospects by lowering market interest rates and creating more scope for banks to lend to the private sector.

On Wednesday night, the Fed left its key fed funds rate unchanged as expected.

It also made no change to its asset purchase plans, but said it “continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period”.

The US central bank said the recession was easing and noted that energy and commodity prices had increased. But it said “substantial resource slack is likely to dampen cost pressures” and it expected that “inflation will remain subdued for some time”.

The Organisation for Economic Co-operation and Development endorsed the view that the global economy was stabilising, revising upwards its growth forecasts.

It is now forecasting a fall in its 30 member states’ output for 2009 of 4.1 per cent, against its previous forecast of a contraction of 4.3 per cent. It now expects modest growth in 2010, versus a slight fall previously. However, it expects the UK economy to contract by 4.3 per cent this year, down from its earlier prediction of a 3.7 per cent decline, and fail to grow at all in 2010.

The OECD argued that the ECB still had room to cut official eurozone borrowing costs.

Economists said that the ECB’s focus on pumping unlimited liquidity could prove effective in helping engineer a eurozone recovery. The one-year offer at the ECB’s main interest rate of just 1 per cent was “a very smart move in a financial system dominated by banks”, said Elga Bartsch, European economist at Morgan Stanley.

The ECB action, which attracted 1,121 bidders – more than usual in ECB operations – had an immediate impact in driving down overnight and longer-term market interest rates, though the full effects are still to feed through.

Don Smith, economist at inter-dealer broker Icap, said: “The massive scale and undoubted success of this tender almost entirely reflects the cheapness of the funds on offer.”

The previous largest amount injected in a single ECB operation was €348.6bn in December 2007. The economic impact will depend on whether demand for liquidity in future ECB market operations is reduced as a result of Wednesday’s action, as well as whether banks step up lending. “They must pass it along,” Lorenzo Bini Smaghi, an ECB executive board member, said in Rome.