[News Analysis] ECB’s Christmas liquidity boost

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ECB’s Christmas liquidity boost
From MarketWatch.com
December 20, 2011, 2:03 PM

The European Central Bank’s long-term refinancing operation, which seems to be rippling through markets in advance of bidding results announced Wednesday, may be a boon to debt-stretched European nations now. But it raises some worrisome questions about what happens if it’s really successful — and European banks stock up on even more sovereign debt.

First a little explainer about what’s happening.

On December 8, the ECB announced a series of liquidity operations designed to ease a credit squeeze that had been driving up yields on benchmark Italian and Spanish debt to eye-popping, unsustainable levels over 6%. The news was largely overshadowed by keen market disappointment that the ECB’s Mario Draghi didn’t signal the central bank was ready to expand its own sovereign-debt purchase program to backstop skyrocketing yields. Read ECB’s announcement.

One of those operations, dubbed LTRO, allows  banks to borrow three-year loans at a  discount against a wider range of collateral, presumably to spur them into buying European sovereign debt in the place of the ECB. Those cheap loans — the Wall Street Journal notes rates could hover around 1% — look attractive compared to  Italian yields of about 6% for both 5-year and 10-year bonds. Read another explainer at BusinessInsider.com.

Analysts said some of Tuesday’s drop in Italian and Spanish bond yields, and corresponding big-time rally in U.S. stocks and easing in the safe-haven dollar, may have to do with European banks buying up debt in advance of the operation.

Here’s what currency strategist at Brown Brothers Harriman says:

    The ECB will conduct its first 3-year repo operation tomorrow.  Yet it is already having an influence on the capital markets. Some banks are thought to have been buying short-term Spanish and Italian bonds that will ostensibly be used for collateral, for example.

According to Chandler, the ECB offered one-day financing to bridge the maturing 7-day repo and Wednesday’s operations, when banks can chose between a 7-day facility, a 3-month facility and the 3-year long-term repurchasing operation.

Given what banks did when the ECB tried a similar operation in June 2009, “we suspect that the results will be at the upper end of market expectations,” said Chandler, or between 100 billion euros and 400 billion euros.

But is a big participation rate — ie European banks loading up on more sovereign debt — really a good thing, and will related enthusiasm last?

Kathleen Brooks, London-based currency analyst at Forex.com,  wonders if  “this is the last ECB-fuelled swan song for the markets.”

“Banks are trying to boost capital levels and de-leverage so why would they want to buy sovereign debt from the currency bloc when there seems no end in sight to the debt crisis?”

– Laura Mandaro