ECB Lends Less Than Forecast in Three-Month Tender (Update2)

By Gabi Thesing
June 30 (Bloomberg) -- The European Central Bank said it will lend banks 131.9 billion euros ($161.5 billion) for three months, less than economists forecast and a sign that the region’s financial industry may be stronger than investors estimated.

Banks tomorrow need to repay 442 billion euros in 12-month funds, the biggest amount ever awarded by the ECB and a key plank in its efforts to fight the financial crisis last year. Demand for the three-month cash today was a litmus test for the health of Europe’s banking system, economists said.

Demand was “surprisingly low and certainly a lot less than markets expected,” said Nick Kounis, chief European economist at Fortis Bank NV in Amsterdam. “It suggests that while there are certainly stresses in the system in some regions, it’s not as bad across the board as many people thought.”

European banks climbed after the announcement and U.S. stock futures extended gains. The euro strengthened more than half a cent to $1.2290.

Financial institutions are wary of lending to each other after Europe’s sovereign debt crisis fueled concern that some governments may struggle to refinance their debts, prompting investors to shun bonds sold by nations including Greece, Portugal and Spain. While the ECB no longer offers banks 12- month loans, the debt crisis has forced it to extend some of its other non-standard measures and to start buying the bonds of big-deficit governments.

171 Banks

The Frankfurt-based ECB still lends banks as much cash as they want at its benchmark rate of 1 percent for periods of up to six months. It said 171 banks asked for the three-month funds today. Banks can currently borrow three-month money from each other in the market at about 0.76 percent.

Eliminating the 12-month facility was part of the ECB’s long-term exit strategy and the bank has taken “every precaution” to avoid a liquidity squeeze, Governing Council member Ewald Nowotny said in Vienna yesterday.

“A lot of the original 442 billion was taken by banks who didn’t need it, banks that saw an opportunity for arbitrage,” said Patrick Jacq, head of interest rate strategy at BNP Paribas SA in Paris. “There was never going to be a repeat of the full amount.”

The ECB flooded the financial system with cheap cash after the collapse of Lehman Brothers Holdings Inc. in September 2008 to unfreeze credit markets and to help pull the economy out of the worst recession since World War II.

Perceived Tightening

Today’s loans may see short-term market borrowing costs rise as there is less excess cash in the system, Commerzbank AG analysts said. With “excess liquidity vanishing,” monetary conditions are “perceived to be tightening,” said Christoph Rieger, an interest rate strategist at Commerzbank in Frankfurt.

Still, the significance of the low take-up in the three- month tender is a “red herring” as European banks will be able to access unlimited ECB funds at various other tenders up until October and probably beyond, said Simon Maughan, a London-based banking analyst at MF Global Securities Ltd.

“Also, the benefit of unlimited cheap money is that you can use it for carry trades and play the yield curve,” he said. “Right now all the uncertainty out there about Spain, Greece and Portugal means that you don’t want to be doing that.”

Europe’s fiscal crisis continues to push up gauges of credit risk as officials conduct stress tests of European banks’ ability to withstand further market turmoil.

The difference between the three-month dollar London interbank offered rate and the overnight indexed swap rate, a gauge of banks’ reluctance to lend, climbed to 0.338 percentage point on June 25, the widest spread in a year. It was at 0.328 percentage point today. European bank shares dropped yesterday, with Allied Irish Banks Plc and Credit Agricole SA leading the declines.

To contact the reporters on this story: Gabi Thesing in London at gthesing@bloomberg.net