The silent bazooka: The three-year loans offered by the ECB to banks have helped stabilise the euro zone

Economist
February 4, 2012

The European Central Bank (ECB) tends to take the long way around. When in 2009 the Federal Reserve and the Bank of England slashed interest rates towards zero and started quantitative easing (buying government bonds with central-bank money), the ECB was more circumspect. It was reluctant to cut its main rate below 1% and loth to buy government bonds directly.

Instead it adopted its own non-standard measures. It offered unlimited loans to commercial banks for up to a year against a broad range of collateral. The ECB’s oblique approach had much the same effect as the route taken by the Fed and others. A flood of liquidity from a €442 billion ($611 billion) auction of one-year ECB loans in June 2009 pushed short-term interest rates close to levels in America and Britain. Banks used much of the cash to buy government bonds, driving down long-term interest rates.

More than two years on, and in far more trying circumstances, the ECB seems to have repeated the trick. Faced with renewed recession, a bank-funding crisis and investor revulsion against all but the safest euro-zone government bonds, the ECB said on December 8th that it would provide unlimited funds for 36 months at its main interest rate (which it cut to 1%), at two auctions. The first of these, on December 21st, attracted bids of €489 billion. That more than matched the amount lent for one year in June 2009, and has had similar effects. Overnight interest rates have fallen to around 0.4%, well below the ECB’s benchmark rate. Longer-term bond yields for investment-grade euro-zone countries—ie, everyone but Cyprus, Greece and Portugal—have dropped, too (see left-hand chart).

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