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Euro Zone Banks Reluctant to Return ECB Funds

Ralph Atkins, Financial Times
Wednesday, 29 Dec 2010 | 3:53 AM ET

Euro zone end-of-year financial market tensions have been highlighted by the European Central Bank’s failure to reabsorb funds it has spent on buying government bonds to combat the region’s debt crisis.

European Central Bank
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European Central Bank

The euro’s monetary guardian had planned on Tuesday to absorb €73.5 billion ($96.5 billion) from the euro zone financial system – equivalent to the amount it has spent on government bonds since May.

But euro zone banks offered the ECB just over €60 billion.

The operation’s failure suggested that banks were reluctant to return funds to the ECB before the year-end period, when they will be under pressure to show strong liquidity on their books.

It was only the second time since the bond-buying programme was launched in May that the ECB has been unable to offset fully sums it has spent on bonds.

The so-called “sterilisation” of its bond purchases is intended by the ECB to offset any inflation impact and make clear that it has not embarked on US Federal Reserve-style “quantitative easing”.

The ECB had hoped to be able to wind down its bond purchases. But the escalation of the crisis triggered by Ireland’s troubled banks in early December forced it to reactivate the programme.

The ECB revealed on Monday that it had again stepped up bond purchases last week, highlighting its role in ensuring that borrowing costs did not spin out of controlfor countries such as Portugal, Ireland and Greece, the nations worst hit by the debt crisis.

Failure by euro zone governments early next year to restore investor confidence in Europe’s 12-year-old monetary union would test the limits of the ECB’s willingness to act.

Analysts played down the immediate significance of Tuesday’s failed liquidity absorbing operation, however, pointing out that the ECB would probably be able to reabsorb the required amount next week, after the year-end period.

Martin Van Vliet, European economist at ING in Amsterdam, said sterilising the bond purchases was largely “cosmetic” as the ECB continued to provide banks with unlimited liquidity.

Nevertheless, the scale of ECB actions showed “quietly but surely they are out there supporting the market”.

Further underlining market nervousness, the ECB reported a surge in demand in its weekly offer of seven-day liquidity, which will last over the year-end.

Some 233 banks were allotted a total of €227.9 billion – up from €193.5 billion offered in a similar operation last week.

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