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ECB Fails to Offset Bond Purchases in Sign of Market Tension

ECB Fails to Fully Offset Bond Purchases With Term Deposits
Light trails made by a passing tram are seen in front of a euro sign sculpture outside the European Central Bank headquarters in Frankfurt. Photographer: Hannelore Foerster/Bloomberg

The European Central Bank failed to fully offset the extra liquidity created by its bond purchases for the first time in seven months, a sign of mounting tensions among euro-area banks.

The Frankfurt-based ECB said today that 85 banks bid a total of 194.2 billion euros ($259 billion) for seven-day term deposits. It had aimed to drain 203.5 billion euros, the amount its bond purchases have created since the program began in May last year. It last fell short of its intended total on April 26.

“It’s just another indication of how uncertain the situation is,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “At the moment, banks are holding more cash than necessary. There’s a lot of caution.”

Banks are hoarding cash as the region’s debt crisis worsens, driving up government borrowing costs and increasing the risk of sovereign defaults. The ECB’s balance sheet rose to a record 2.42 trillion euros in the week through Nov. 25, about 500 billion euros more than a year ago, as banks tapped it for funds rather than trading with one another. The ECB, which lends banks as much cash as they want at its benchmark interest rate, also said today that weekly lending rose to a two-year high.

Euro Declines

While the ECB has failed to “sterilize” its bond program at least four times before, this is the first time it has happened since the central bank expanded the program to buy Italian and Spanish bonds in August.

The euro pared its gain against the dollar after the ECB’s announcement, falling about half a cent. It traded at $1.3331 as of 4:04 p.m. in Frankfurt.

The ECB tries to drain the same amount from the banking system each week that its purchases have created to ensure they don’t swell the money supply and fuel inflation. It says this is what distinguishes its bond program from those of the Federal Reserve and Bank of England, which aim to increase the money supply to boost economic growth.

The ECB began buying Italian and Spanish debt after Europe’s debt crisis spread. It says the purchases are aimed at ensuring transmission of its interest rates on financial markets. Bond yields have nevertheless risen across the 17-nation euro region as investors lose confidence in Europe’s ability to contain the crisis.

The bond-market intervention has split the ECB council, with Executive Board member Juergen Stark announcing on Sept. 9 that he will step down at the end of the year and Bundesbank member Jens Weidmann also opposing the purchases.

‘Natural Limit’

Rabobank economist Elwin de Groot estimated earlier this month that there is a “natural limit” of 300 billion euros the ECB can sterilize. Once it hits the limit, officials will be forced to decide whether they are willing to go beyond the ECB’s official mandate of maintaining price stability, De Groot wrote in a Nov. 8 note to investors.

Some economists say the ECB’s attempts to offset its bond purchases are meaningless because it already lends banks as much cash as they want in its refinancing operations, allowing them to effectively determine the amount of money in the system.

“It’s irrelevant for monetary policy purposes because in some sense the liquidity operations already led to a large expansion of the balance sheet,” said Jens Sondergaard, an economist at Nomura International Plc in London. “And it’s expanding irrespective of whether they’re sterilizing or not.”

The ECB loaned banks 265.5 billion euros in its seven-day main refinancing operation earlier today, the most in more than two years. The number of bidders was 192 compared with last week’s 178.

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