ECB stuck feeding southern Europe’s cash addiction

August 20, 2010

Spain ECB borrowing

Commercial banks in southern Europe are increasingly addicted to cheap central bank money after dealers shut them out of money markets. Due to this dependency, the European Central Bank will have little option but to keep offering banks cold hard cash for almost nothing – currently it prices its loans at 1.0 percent.

Economic growth in the euro-zone core has been robust lately, but southern Europe has been hit hard on several fronts recently and is falling badly behind. First, the sovereign debt crisis hit Greece and other southern periphery countries, then bank stress tests showed 6 out of 7 failing banks were in Spain or Greece, and then the region posted only tepid economic growth.

Bank borrowing from the ECB shows increasing strains in southern euro-zone’s financial sector while banks elsewhere are getting back on their feet, but the fear of contagion from country to country will keep the ECB on its toes. Banks in Greece borrowed twice as much last month as they did in July 2009, even though outstanding central bank lending fell 18 percent over the same time. Banks in Portugal borrowed five times as much in July 2010 as they did a year earlier, and borrowing also rose in Spain and Italy.

“The full-allotment fixed-rate repos will stay well into next year,” said Michala Marcussen, Societe General chief economist. “Beyond the first quarter of next year, the overall economic environment will be the key determinant in how much longer it gets carried. In all likelihood it could get carried further ahead.”

The ECB tried to reintroduce limits to borrowing in April but was forced into a U-turn by the sovereign debt crisis, returning to its full allotment policy in May. Fourth-quarter plans are due to be revealed in September, with markets expecting full allotment to continue.

Among the ECB’s 22 Governing Council members, Cyprus’s Athanasios Orphanides and Ireland’s Patrick Honohan have indicated the unlimited funding should continue, and on Friday Germany’s Axel Weber made clear exit discussions should not resume until early next year. His dovish tone got analysts’ attention.

“The key message is that the ECB is willing to stay there as long as it has to and that it believes that it needs to be present and keep those full allotments,” Marcussen said.

Analysts said the ECB would not be doing its job as guardian of the economy were it to ignore problems in the south.

“If the ECB was not present, it would not be assuming its role as a central bank,” Informacao de Mercados Financeiros economist Filipe Garcia said.

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