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ECB mops up after eurozone liquidity operation

After flooding eurozone money markets with cheap cash, the European Central Bank (ECB) mopped up surplus funds on Wednesday, a well-worn practice aimed at reassuring subprime-shy banks while taking care not to fuel inflation.

After providing almost 350 billion euros (US$502 billion) to commercial banks on Tuesday, the ECB withdrew more than 133 billion euros a day later in what might seem like contradictory moves.

"We are not pouring in liquidity," ECB President Jean-Claude Trichet explained in an appearance at the European Parliament in Brussels. "The loans are paid back too."

The ECB has nonetheless been generous in offering ample supplies of liquidity at rates well below high levels, which themselves reflect tension that has persisted since the US market for subprime loans collapsed a few months ago.

On Tuesday, interbank lending rates eased considerably after the ECB's biggest ever single cash provision, a two-week operation aimed at ensuring banks would have the liquidity they needed to make it though the end of the year.

In some cases, interest rates charged by banks to each other showed the biggest drop in almost six years.

The ECB's goal is to re-establish confidence among banks, which no longer want to lend to each other because they are unsure how exposed borrowers might be to subprime-related losses.

Bank jitters are compounded by the coming end of the year, when many institutions close out their books.

They want to constitute ample supplies of cash "to show shareholders and investors they are not at risk and can cope with the consequences of the subprime crisis," said Gilles Moec, a senior economist at Bank of America.

Meanwhile, Trichet made it clear that "we do not pretend to cure the situation" through repeated cash provisions of tens of billions of euros.

The bank was simply acting on a short-term basis to keep lending rates from soaring out of sight.

When, on the other hand, they fall too much, the ECB also acts to prevent excessively cheap funds from fueling inflation. A banking source said on Wednesday that overnight interbank rates had fallen to 3.75 percent late on Tuesday, below the ECB benchmark lending rate of 4.0 percent.

That led to the operation on Wednesday that offered to borrow money from commercial banks at 4.0 percent, a move that pulled rates back up.

The ECB calls such actions "fine-tuning" operations and they normally involve money lent or borrowed for short periods of time.

But while the various actions can stabilize markets temporarily, they have not produced real long-term effects until now. The ECB hopes that when banks publish annual results losses stemming from the crisis will become clear and confidence will return to markets.
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