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ECB’s Forecast-Beating Liquidity Injection Spurs Markets

The second round of the European Central Bank’s mass release of loans at its record low interest rate into the European banking system was slightly higher than expectations, sending European markets higher on Wednesday.

Mike Kemp | Getty Images

The euro fell slightly against the dollar after the ECB announced that the second long-term refinancing operation (LTRO) with a maturity of three years had a take-up of 529.5 billion euros ($713 billion) Wednesday, ahead of analysts' predictions of around 500 billion euros. In December’s operation, 489 billion euros was taken up.

This time, 800 banks around Europe took up the cheap funding offered by the LTRO, up from 523 last time round, indicating that the initial stigma surrounding the operation had been removed.

Banks including HSBC, Belgium’s Dexia, Austrian bank Erste Group, and Spain’s CaixaBank and Banco Bilbao told Dow Jones that they had taken up funds from the second LTRO.

Analysts welcomed the news but urged caution on its long-term effects.

“Whether this is the 'final' LTRO as indicated by ECB or not will become the true indicator," Steen Jakobsen, chief economist, Saxo Bank wrote in a research note.

"If this was the last one then history tells us that ending access to extremely easy money should see risk-off, if however the market sees through the ECB and know they will do more as the economic situation deteriorates, then this is merely another step towards explosion of the ECB balance sheet which short-term is very good, and long-term risks inflation and debasing,” Jakobsen added.

February’s figure includes a greater-than-expected net liquidity, or “new money” addition of 444.5 billion euros – much larger than the approximately 210 billion euros added in December. The lower amount of “new money” in December happened because banks slashed their use of the existing Main Refinancing operation and of the shorter, 3-month LTROs, substituting them for the new 3-year loans.

The cheap long-term loans have helped stock markets around the world rally in 2012. Wednesday’s announcement should “underpin the general support for fixed income assets” according to Norbert Aul, rates strategist at RBC Capital Markets.

Spanish and Italian banks, the biggest buyers in the last operation, used their holdings of their own sovereign bondsas collateral for the LTROs. This helped reduce sovereign bond yields, which were threatening to stay at unsustainable levels that would make debt repayments impossible.

“On the one hand, the large take-up suggests that liquidity will continue to improve and that euro zone institutions will be more robust moving forward. However, some might take it as a clear indication of ongoing instability,” Richard Driver, currency market analyst at Caxton FX, wrote in a research note.

“The first LTRO was a major success and [European Central Bank president Mario] Draghi is right when he says it has averted a credit crunch. Nonetheless, it is often the case that repeated monetary easing measures produce diminishing returns, so I don’t think we can expect LTRO 2 to result in the same easing of pressures in Italian and Spanish bond yields that December’s ECB loans triggered.”

Analysts were predicting the long-term refinancing operation (LTRO) would get around 500 billion euros; it was ahead of the 489 billion euros taken in December’s operation.

In previous auctions, the money usually had to be paid back within three months, six months or 1 year. The ECB’s first 3-year LTROs took place in December last year.

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