FRANKFURT, April 22 (Reuters) - The European Central Bank failed to offset as much of the money it has spent on government bonds as it planned to on Tuesday, falling short for the second week running as the amount of spare cash in the banking system falls to critical levels.
The ECB takes an amount equivalent to its holdings of euro zone government bonds as weekly deposits from banks to offset its buying of bonds at the height of the financial crisis. It does so to neutralise any threat that it will fuel inflation.
But many banks are repaying early the loans they took from the ECB at the peak of the euro zone crisis, and have set aside tens of billions of euros ahead of an ECB health check of the sector, leaving them with less cash to deposit at the central bank.
The drop in the amount of surplus cash in the system puts upward pressure on market interest rates. The ECB earlier this year debated ending its sterilisation operations to loosen lending conditions but opted to keep them going for now.
Excess liquidity now stands at around 123 billion euros.
“Excess liquidity is seen as not high enough,” said a money market trader who asked not to be named, explaining why banks preferred to hold on to funds rather than parking them at the ECB for a week for a return of 0.25 percent.
The ECB drew back 166.780 billion euros ($230.22 billion) on Tuesday in seven-day deposits versus a target of 172.5 billion, equivalent to the size of its first and now terminated sovereign bond-purchase plan, which remained unchanged in the week to April 18.
Last week, the ECB also failed to offset the full amount.
Banks also took 9.65 billion euros more in the ECB’s weekly main refinancing operation on Tuesday.
The so-called Securities Markets Programme (SMP) was replaced by a new and yet-to-be used plan dubbed Outright Monetary Transactions (OMT) in September 2012. The ECB holds the bonds it bought under the SMP to maturity. ($1 = 0.7244 Euros) (Reporting by Eva Taylor; Editing by Hugh Lawson)