ECB PUMPS RECORD 442 BN EUROS INTO SYSTEM / THE FINANCIAL TIMES BREAKING NEWS

ECB pumps record €442bn into system

By Ralph Atkins in Frankfurt

Published: June 24 2009 11:05

The European Central Bank has pumped a record €442.2bn into the eurozone banking system in a first-ever offer of unlimited one-year funds as it battles continental Europe’s severe recession.

The results of the operation, part of ECB efforts to revive the eurozone economy by rejuvenating the financial system, highlighted expectations that liquidity will not be available again on such favourable conditions. The previous largest amount injected in a single ECB operation was €348.6bn in December 2007.

Demand for the one year funds – offered at the ECB’s main policy rate of just 1 per cent – appears to have been boosted significantly by financial markets’ growing conviction that ECB interest rates will not fall any further.

The operation is expected to push down significantly market borrowing costs, including 12 month interest rates, which are already lower than in the US. Julian Callow, European economist at Barclays Capital, added: “This gives the banking sector greater confidence still in order to be able to make loans and acquire assets.”

Since the collapse of Lehman Brothers last September, the ECB has slashed its main policy rate by 325 basis points to the lowest ever rate. But ECB policymakers have signalled that further reductions are unlikely – unless the eurozone economy takes a substantial further turn for the worse.

At the same time as cutting official borrowing costs, the ECB also expanded its armoury substantially by agreeing to match in full eurozone banks’ demand for liquidity for periods of up to six months.

Although such steps have attracted less attention, ECB policymakers argue the effects on the recession-hit eurozone economy have been similar to “quantitative” or “credit” easing measures unveiled by the Bank of England and US Federal Reserve.

The decision to offer funds for one-year – announced in May and dubbed by some economists a “stimulus by stealth” - marked a further escalation of the ECB’s offensive. Unlike in previous operations, however, banks appear not to have held back in the expectation that interest rates will subsequently fall. Creating an additional incentive, the ECB reserved the right in future one-year operations to charge an interest rate above its main policy rate.

Confirmation that the ECB was in a “wait and see” mode as regards future interest rate decisions was provided by José Manuel González-Páramo, an ECB executive board member. He told a Spanish newspaper: “Let’s wait and see how the latest measures work. We did not decide that 1 per cent was the lowest (interest rate) level imaginable in any scenario, but we do think that it is the appropriate level given the information that we have currently available.”

However the Paris-based Organisation for Economic Co-operation and Development argued in its latest report that the ECB still had scope to cut official borrowing costs.

The pace at which the eurozone economy was contracting decelerated sharply in the second quarter, according to latest survey evidence. But the ECB and other economists have been wary about forecasting any early return to growth.

Copyright The Financial Times Limited 2009