The ECB last month lent banks an unprecedented 489 billion euros ($637 billion) for three years. The ECB is flooding the banking system with cheap money in a bid to avert a credit crunch after the market for unsecured bank debt seized up and funding from U.S. money markets dries up. Politicians, including French President Nicolas Sarkozy, are pushing the banks to use the loans, which carry an interest rate of 1 percent, to buy higher-yielding southern European sovereign debt, thereby forcing down borrowing costs in the region.
The ECB is offering banks unlimited cash as lenders try to refinance more than $765 billion of debt that matures this year, just as institutional investors remain reluctant to buy debt from all but the safest banks.
Lenders in Italy, Spain and France are using the loans to purchase more of their domestic government debt to profit from the difference between the interest rate on the ECB money and the higher yield on sovereign securities.
Two-year Spanish and Italian notes have rallied since the ECB said on Dec. 8 it would offer banks unlimited three-year money in exchange for eligible collateral. Yields on two-year Spanish notes have fallen 178 basis points to 3.14 percent while their Italian equivalents fell 269 basis points to 3.54 percent. Longer-dated securities underperformed shorter-duration notes on concern austerity plans won't plug deficits and reduce Europe's debt load.
The ECB is still deciding what will constitute acceptable collateral,” Marchel Alexandrovich, an economist at Jefferies International Ltd. in London said. “If criteria are loosened enough, then demand for cheap money will undoubtedly swell up and we may well see a figure in excess of 1 trillion euros” at next month's operation.
Credit Suisse's Porter said he expects banks to borrow slightly more than in December, about 500 billion euros, because lenders won't want to be put at a competitive disadvantage when their peers can borrow cheaply from the ECB.
“This will remove some of the refinancing risk the banks face and the markets are reacting positively after a bit of a delay,” Porter said in a telephone interview. “But the more fundamental question is how ‘long can you run a banking system like this?'”
It would seem that these measures will at least be in place through the US election. In 2013, Europe should have austerity and other measures in place and would then be able to start turning off the printing presses.
This seems to mean that there should be no collapse of Europe in 2012. The US will be able to continue a modest recovery in 2012. China will not get hit by a collapse in Europe. The muddle through world economic scenario looks pretty good.
Talk of quantitative easing 3 (QE3) in the US in May/June would be further insurance that there would be no recession in the US that would cause a problem for re-election campaigns in the US.
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