ECB’s 442 Billion Euro injecton from June 24 is not working. Banks still refusing to lend funds, hoard cash.


The below article by Guardian UK is full of direct references to deflation:

  1. The central bank hopes commercial banks will lend the funds on to companies and consumers, which would stimulate spending. But policy makers do not appear very confident of success.
  2. if central banks’ efforts to kickstart the economy failed because commercial banks were too cautious in lending
  3. But moving money around among banks does not necessarily mean it is being channelled into consumption and investment.
  4. “How this money gets allocated depends on investor sentiment and…where banks believe their money will be safest and most profitable for the risk taken,”
  5. One danger is that banks could simply hoard funds, redepositing them overnight at the ECB
  6. Overnight deposits at the ECB soared to a 4-1/2-month high of 143 billion euros on Thursday as banks took delivery of the fund injection.
  7. Loans to the private sector have continued to shrink month-to-month
  8. “It will boost lending, because there is more planning security. But only partially, because banks will remain cautious to take on extra risks.”
  9. German banks were reluctant to take on new credit risks, which they would have to back up with further capital as clients’ creditworthiness declined in a recession.
  10. Goldman Sachs economist Erik Nielsen said the ECB would probably keep lending banks one-year funds at a flat rate rather than adding a margin as it has said it might.”If it still doesn’t work, then our forecast of two more rate cuts in the late summer suddenly looks a lot healthier than it did in recent weeks,”

All this is direct evidence of violent credit deflation. Banks are not stupid, they know the economy is in decline, loan defaults are rising, assets that back them up are losing value, so the safest thing is NOT to lend and to keep the freshly printed Euros with the ECB. This is deflation and ECB cannot hide it anymore, despite what they are saying about it. Their actions tell us a story of panicky efforts in an attempt to prop up the imploding credit. 442 Billion Euros lent out in one single day is a staggering amount of money even in the context of what FED has done so far.

* ECB urges banks to lend on the funds it injected
* But banks may hoard or invest in government bonds
* ECB may have to consider fresh steps
By Andreas Framke and Eva Kuehnen
FRANKFURT, June 26 (Reuters) – After flooding the money market with a record amount of funds, the European Central Bank is now grappling with the most difficult part of its operation: making sure the money fuels economic growth.
By lending banks 442 billion euros of one-year funds at a 1 percent rate on Wednesday, the ECB doubled the liquidity it is providing to the banking system, to a massive 897 billion euros.
The central bank hopes commercial banks will lend the funds on to companies and consumers, which would stimulate spending.
But policy makers do not appear very confident of success. Some are mounting a vocal campaign to persuade commercial banks to use the money in the way they want — and backing up their persuasion with a thinly veiled threat of further action.
ECB Executive Board member Lorenzo Bini Smaghi and Governing Council member Axel Weber both told banks this week that they should toe the line after the fund injection.
“Now they have to pass it on to the real economy, make loans to firms,” Bini Smaghi said. “It will be up to the relevant authorities to ensure that they do.”
Weber said that if central banks’ efforts to kickstart the economy failed because commercial banks were too cautious in lending, central banks could bypass the commercial banks and take more direct measures.
“I assume that a credit crunch is avoidable, if banks cooperate,” he said.
Weber did not spell out what action the ECB might take if banks did not cooperate. But one option would be for the ECB to lend directly to companies, as the U.S. Federal Reserve and the Bank of England are doing; Weber said he saw no need for fresh action “for the moment”.
UniCredit economist Aurelio Maccario said the ECB’s jawboning made sense:
“Moral suasion is an important tool in times like these and banks know that the ECB support has been decisive for them.
“It’s a matter of finding an equilibrium between the need to keep the credit flowing and avoid banks embarking on too-risky loans that will result in large losses in years to come.”
MARKET RATES FALL
The early signs are good that the extra cash is flowing through the banking system. Bank-to-bank interest rates fell to new record lows on Thursday, with the three-month Euribor rate dropping to 1.145 percent — close to the ECB’s main policy rate at 1 percent.
The average rate for overnight cash sank to 0.432 percent, and analysts expect it to continue sliding to very near the ECB’s lowest policy rate of 0.25 percent, although the ECB may absorb back some funds in fine-tuning operations later.
But moving money around among banks does not necessarily mean it is being channelled into consumption and investment.
“How this money gets allocated depends on investor sentiment and…where banks believe their money will be safest and most profitable for the risk taken,” said Tullett Prebon G7 markets economist Lena Komileva.
One danger is that banks could simply hoard funds, redepositing them overnight at the ECB, in case of fresh shocks to the financial system. This danger seems much smaller than it was a few months ago as fears of major bank failures have eased.
Overnight deposits at the ECB soared to a 4-1/2-month high of 143 billion euros on Thursday as banks took delivery of the fund injection. But Komileva said the injection was simply too big for banks to mobilise immediately, and they would inevitably take time to decide on longer-term destinations for the cash.
Another risk is that banks could simply pour their money into buying safe government bonds. With ten-year German government bond yields at just under 3.5 percent, banks could earn a hefty margin of 2.5 percentage points.
“Among many things, banks tend to play the carry trade,” Morgan Stanley economist Elga Bartsch wrote in a note to clients. “New funds could be channelled into the bond market, notably the short end.”
Research published in the ECB’s June bulletin shows banks’ purchases of government debt tend to rise as short-term money market rates fall.
A flood of money into government bonds could have some positive effects by pulling down the entire yield curve, reducing home mortgage rates and making it cheaper for firms to raise money by issuing bonds. Attractive spreads on government bond holdings could help banks rebuild their balance sheets.
Effectively, the ECB would be achieving indirectly many of the goals that the Fed and the BoE have been seeking to accomplish through direct purchases of government bonds.
LOANS
But a rush of funds into government bonds could divert money from loans to firms and households. Loans to the private sector have continued to shrink month-to-month; ECB President Jean-Claude Trichet said on June 4 this was mostly due to falling short-term lending to firms.
Michael Schubert, economist at Commerzbank, said he saw potential for a rebound in private sector loans.
“It will boost lending, because there is more planning security. But only partially, because banks will remain cautious to take on extra risks.”
The head of the German banking association, Andreas Schmitz, said German banks were reluctant to take on new credit risks, which they would have to back up with further capital as clients’ creditworthiness declined in a recession.
UniCredit’s Germany head, Theodor Weimer, said his bank was doing what it could to extend loans, but had to stretch itself as refinancing costs for banks had risen massively despite record-low interest rates.
If banks do not boost lending, the ECB will have at least two major options. If it decides lending directly to companies is too radical, it could cut its benchmark rates further.
Although most analysts expect the ECB to keep rates on hold through this year and next, 13 of 82 economists in a Reuters poll see further room for easing this year — as does the Organisation for Economic Cooperation and Development.
Goldman Sachs economist Erik Nielsen said the ECB would probably keep lending banks one-year funds at a flat rate rather than adding a margin as it has said it might.
“If it still doesn’t work, then our forecast of two more rate cuts in the late summer suddenly looks a lot healthier than it did in recent weeks,” he added.

It will take some time before it is clear if loans are starting to rise in response to this week’s fund injection; euro zone data for July will come out at end-August.

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