CORRECTED: ECB soaks up cash to offset help through bond buying

5th October 2010, Comments 0 comments

The European Central Bank revealed on Tuesday the extent of new strains and risks in the eurozone financial system, saying it had increased 10-fold the cash it has soaked up from the banking system.

The bank extracted 1.4 billion euros by attracting this amount into deposits at the ECB, because it had injected exactly the same amount to help some financial institutions recently by buying government bonds from them.

The ECB is worried that by providing cash to parts of the eurozone financial system, it might stoke up inflation generally.

One analyst suggested that the bond-buying move was part of a decision taken "to tame" trading in debt issued by debt-burdened eurozone countries.

The latest data gives insights into how the ECB has had to ramp up help for parts of the banking system, playing an excpetional role as buyer of last resort, just as the value of Irish and Portuguese bonds was being pushed down sharply on debt markets in the last two weeks.

This means that eurozone countries under pressure from heavy public deficits and debt are having to pay high rates to borrow to fund the gap between tax revenue and spending. Ireland and Portugal are among governments which have borrowed by issuing bonds recently.

The ECB took in one-week deposits worth nearly 1.4 billion euros (1.9 billion dollars) from commercial banks, a move which offset a sharp jump in the central bank's purchase of government bonds last week.

"This is the largest weekly settlement since early July, suggesting that the ECB tried to tame periphery markets last week," Citi chief eurozone economist Juergen Michels said.

Moody's Investors Service said on Tuesday that it might downgrade Ireland's sovereign debt rating owing to the cost of rescuing Irish banks.

The ECB collects one-week deposits from banks equal to the amount it holds in government debt to avoid fuelling inflation, which rose in September to 1.8 percent, the highest 12-month figure for nearly two years.

The amount bought last week, 1.384 billion euros, was 10 times greater than the previous week and was purchased amid renewed market pressure on debt issued by Ireland and Portugal.

The latest operations brought the total amount of ECB sovereign debt purchases to 63.5 billion euros, the bank said.

The ECB has pursued its controversial Securities Markets Programme to underpin a key market for eurozone sovereign financing, and UniCredit analysts said the central bank "has likely bought 2.2 billion in Irish bonds (around 80 percent of its total purchases) since early August."

When the programme began in May, weekly purchases hit a high of 16.5 billion euros, before falling off to almost nothing in early August.

© 2010 AFP

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