Analysis: More ECB bond buys may need new cash-mopping tools

Thu Aug 30, 2012 11:31am EDT
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By Marius Zaharia

LONDON (Reuters) - A new round of government bond purchases may eventually force the European Central Bank to use some of its yet-to-be-tested tools to soak up the additional cash in the euro zone banking system.

This may include extending the time its is willing to hold commercial banks' money, or even issuing bills.

At its meeting on September 6, the ECB is expected to unveil a plan to bring down Spanish and Italian borrowing costs and ease the euro zone's debt pains by buying more debt under some conditions.

Because little detail has been made public, market participants are speculating about how this will work, including so-called "sterilisation", which central banks use to ensure that there is no extra money in the system as a result of such a policy.

This is usually done by offering commercial banks good interest rates to deposit money with the bank for a week. But it may be that the amounts involved this time are too great for that.

Analysts generally expect the ECB to sterilize any new bond buying because doing so is key to keeping the ECB's inflation targeting mandate credible and to set it apart from other major central banks such as the Federal Reserve and Bank of England which have simply printed money to help their economies recover and not drained it.

That would be outright quantitative easing, which has strong opposition in Germany, which has philosophical concerns about anything that would smack of ECB funding governments.

To have a significant and lasting impact on Spanish and Italian bond yields, however, the ECB's next forays into bond markets may need to be of the order of hundreds of billions. Add that to the 209 billion euros worth of previous bond purchases the ECB is already draining every week from the system and some analysts say there could be failed auctions of one-week deposits.   Continued...