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ECB to launch second wave of euro ‘quantitative easing’

For second time in two months European Central Bank floods markets, with 1% three-year loans that may amount to €1tn

The European Central Bank will on Wednesday step up its campaign to stabilise the euro, forestall a new credit crunch, and shore up troubled banks when it floods the markets with hundreds of billions of easy money for the second time in two months.

The offer of three-year loans to banks at the cheap interest rate of 1% represents a boon for the banking sector in the troubled eurozone periphery, and is broadly seen as a masterstroke by ECB president Mario Draghi of Italy, who launched the policy in December in one of his first moves as president.

While analysts speculate that the take-up of what amounts to a eurozone policy of quantitative easing could reach €1tn (£848bn) when the funds are made available on Wednesday, the expectation is that the borrowing will roughly emulate the first round of lending in December when more than 500 EU banks netted €489bn.

The Draghi decision took the heat off the ECB, which was being heavily criticised for declining to take a more interventionist role in the euro crisis, with calls for a rewrite of its rulebook to become the eurozone’s lender of last resort, and for it to go on a bond-buying spree.

Instead, the ECB effectively sub-contracted the bond-buying role to the banks, especially in Italy and Spain, lending them cheap money that they then lent on to their governments at hefty profits.

The policy has had the effect of bringing down soaring borrowing costs for Italy and Spain, increasing demand for vulnerable sovereign paper, and easing the pressure on the eurozone at the height of the Greek debt drama.

“The ECB’s December move to provide massively greater liquidity to the banking system was the single most important thing to happen in the eurozone last year,” said Simon Tilford, chief economist at the Centre for European Reform thinktank. “This has bought time by easing the pressures on the banks, who in turn have bought more government debt – at least in Italy and Spain – than had looked likely.”

The cheap money has overwhelmingly flowed to the eurozone’s weakest corners, feeding a grumbling campaign that is getting louder in the northern, more disciplined creditor countries in the single currency.

Of the €489bn taken up by European banks in December, €325bn was tapped by banks in Greece, Ireland, Italy and Spain.

The decisive move in December came at a time of intense political quarrelling over whether and how to save Greece. Draghi’s policy has been broadly applauded. But the scheme is also becoming increasingly contentious, especially in the key eurozone country, Germany, where it is being argued that the liquidity provision is risky, encouraging banks to take bad decisions, and that it is turning the eurozone surreptitiously into a “transfer union” where taxpayers in the northern creditor countries in the north are ultimately liable for the easy profits accrued by southern European banks. And that the policy will erode Germany’s strong credit rating.

Central bankers in Germany and Finland have recently warned that excessive liquidity from the ECB is generating “risky incentives” in the banking sector, and are not keen to see Frankfurt roll out a third round of cheap credit.

Although the policy “may mitigate the [eurozone] periphery’s funding needs for some time to come, it is clear that several officials are concerned about the impact of liquidity provision upon risk-taking activity,” said Bank of New York analyst Neil Mellon.

“There is a genuine fear that unprecedented lending could even generate ‘zombie’ banks … The greatest risk is that in swelling its balance sheet, the ECB has become increasingly hostage to the fortunes of the eurozone economy and loans that are of unknown discounted value.”

The impact of the policy on the real economy also appears much more negligible than had been hoped. Draghi argued in December that the liquidity operations had prevented “a major, major credit crunch.”

But data from the ECB this week show that the banks taking advantage of the scheme are opting either to lend to their governments or to repair their own balance sheets, with lending to businesses and homeowners stagnating or receding.

Bank lending to businesses collapsed by a massive €35bn in December and by a further billion last month. Lending to homebuyers was slower last month than in December, the ECB reported, 1.8% up on a year ago compared with 2.3% the previous month.

“There is no sign that the banks are stepping up their lending to business and households, and with the economic outlook so poor it is hard to see that changing over the coming months,” said Tilford.

“There is no doubt that the banks’ drive to shrink their balance sheets is exacerbating the economic downturn.”

Draghi acknowledged last week that if the aim was to maintain the supply of credit to businesses and households, the policy was less than successful.

“One expectation now is that having satisfied their funding needs for this year, at least the banks will be more inclined to use the money – which was our prime expectation really – to expand credit to the real economy,” he said. “We have certain aspirations and ambitions that what we do actually helps the real economy, and we will see what happens.”

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