ECB prepares to open liquidity floodgates again

In an unprecedented move last December, the ECB announced it would lend as much as banks wanted at an ultra-low interest rate of 1.0 per cent for a period of three years so as to keep credit flowing in Europe at a time when banks are increasingly wary of lending to each other in the current debt crisis.

In the end, some 523 banks lined up to borrow a record 489.2 billion euros ($655 billion).

At the time, ECB chief Mario Draghi said that a second such three-year auction of funds -- known as a long-term refinancing operation or LTRO -- would be held on February 29 and he estimated that demand for the new cash would likely be just as strong.

Draghi, in office only since November, has since been keen to draw attention to the success of the operation.

In an interview with the German daily Frankfurter Allgemeine Zeitung on Friday, Draghi said "the impact of the three-year tender was underestimated when I announced it in December, because many people expected the ECB to expand its government bond purchases, the famous 'bazooka'.

"Maybe I should have called the tender 'Big Bertha' when I announced it, then everyone would have listened," Draghi said.

Tensions in the banking system do indeed appear to have eased, borrowing costs for debt-wracked countries such as Spain and Italy have come down, stock markets across Europe have rallied and confidence is on the rise.

Ever since the eruption of the crisis, the ECB has come under intense political pressure to step in and save eurozone countries sinking under huge mountains of debt.

But the bank has argued from the very beginning that it is up to overspending governments to get their finances in order and restore the markets' confidence in their ability to repay their debts, which is the underlying cause of the eurozone's current ills.

The ECB insists its fire-fighting efforts must be limited to acting as lender of last resort for banks only and not for governments.

Nevertheless, economists and ECB watchers are impressed with Draghi's performance so far, after just four months in office: in addition to a wide range of liquidity measures, the bank has cut interest rates twice, effectively reversing two rate hikes last year.

Nobel-prize winning economist Paul Krugman, writing in the New York Times, was full of praise for Draghi.

He "brushed aside the inflation-worriers and engineered a large expansion of credit, which was just what the doctor ordered," Krugman wrote.

John FitzGerald of the Economic and Social Research Institute, a Dublin-based think tank, similarly believed the LTRO has worked "surprisingly well in getting the ECB off the hook.

"There was always talk of the ECB's 'big bazooka'" to solve the eurozone crisis and this was it, FitzGerald told AFP.

"If (Draghi) pulls this off and gets the ECB out of this hole, the pressure to act, without infringing on statues, then he'll have done a very good job," the economics professor said.

While Draghi said the aim of the new funding was for banks to lend to households and businesses, there have been concerns that banks are simply hoarding the cash instead, as banks have been parking record amounts of cash in the central bank's overnight storage facility.

Furthermore, in its regular quarterly bank lending survey, the ECB calculated that growth in loans to the private sector slowed substantially in December.

"The banks need to play the game, to redistribute part of the loans from the ECB. But that's a question of priorities, since they themselves are facing constraints," said Natixis analyst Cyril Regnat.

Marie Diron, economist at Ernst & Young, noted banks had responded enthusiastically to the ECB's first three-year loan offer "and we expect a significant take-up again next week."

But she saw some downsides to the LTRO, too.

"It threatens to make banks in some countries dangerously dependent on ECB financing. Italian and Spanish banks now have five per cent of their assets financed by the ECB and the more this rises, the more difficult it may be for banks to attract other financing," she said.

"Overall, we think that the ECB was right to step up its support to the banking sector. But we would warn against any statement that this marks a 'mission accomplished' as one ECB official suggested," she said.