Insight: ECB preparing to close liquidity floodgates

Tue Feb 21, 2012 3:50pm EST
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By Paul Carrel and John O'Donnell

FRANKFURT/BRUSSELS (Reuters) - The European Central Bank wants its second offer of cheap ultra-long funds next week to be its last, putting the onus back on governments to secure the euro zone's longer-term future.

Powerful members of the central bank's 23-man governing council are privately hoping demand at the February 29 auction will fall well short of the 1 trillion euros some expect, backing their view that it should be the last.

Central bank sources say they are worried that banks will become too reliant on ECB funds, removing the incentive to restart lending between themselves.

The ECB first offered banks low cost three-year money in December to stave off a freeze in interbank lending that threatened to make the region's debt crisis much worse.

Banks flocked to take advantage of the offer, filling their coffers, and ECB President Mario Draghi said "a major, major credit crunch" had been averted.

Some European officials have been hoping the central bank would carry on supporting the economy with a series of subsequent cheap money auctions, known as LTROs.

But the ECB wants to keep pressure on governments to improve their defense of the euro zone with better economic policies and by bolstering their European Stability Mechanism (ESM) firewall which will come into being by mid-year.

Making hundreds of billions of euros easily available to banks over a three-year period also risks fuelling a credit binge that some central bankers worry could push up inflation.   Continued...

The European Central Bank (ECB) President Mario Draghi reacts during the monthly news conference in Frankfurt, February 9, 2012. REUTERS/Alex Domanski