LONDON The European Central Bank's offer of cheap long-term cash is an attempt to prevent a rapid bank deleveraging shock rather than U.S.-style money printing that will filter through to the real economy and leach into other markets.
Italian and Spanish government bonds may benefit a little from newly flush banks buying them. But the money is most likely to be used to help ease banks' immediate refunding needs - they need to sell up to 3 trillion euros of assets to deleverage and meet strict new regulatory capital requirements.
On the other hand, the fact that a credit crunch has been averted and deleveraging can now happen more smoothly removes twin potential threats to Europe's struggling economy.
And the ECB's three-year ultra-cheap loans may ease a wave of capital outflows by U.S. money market funds from European banks, which has gummed up interbank lending.
The borrowing of 490 billion euros by over 500 banks - the largest ever amount of liquidity pumped into the financial system - represents nearly two thirds of all the European bank bonds maturing in 2012. It is almost 1-1/2 times the 2012 combined sovereign bond issuance of Spain and Italy.
The ECB will follow up with another similar operation in February in a move designed to directly help banks which need to raise capital.
But it is very different to the quantitative easing (QE) by the Federal Reserve which bought more than $2 trillion of Treasuries and other securities with new money to kick-start the U.S. economy in 2008-2010.
"Genuine QE creates money and buy assets, so there's direct intervention in the financial market. What the ECB is doing is making liquidity available to banks against collateral. For some people that may give an empty feeling as it's not the bazooka they were hoping for," said William de Vijlder, chief investment officer at BNP Paribas Investment Partners.
"But with the liquidity available, banks also better manage their own balance sheets. That creates more flexibility. It's a very important step in terms of liquidity. At some point in 2012 people will say this has contributed to a more positive market evolution."
Whether or not it shores up banks and encourages them to lend, there is little prospect of the cash bleeding into commodities and emerging markets as much of the U.S. money did.
"I don't think commodities are going to be their first priority. European banks and governments are like two drowning men clinging to one another trying to keep their heads above water," said Sean Corrigan, chief investment strategist at Diapason Commodities Management, which has $8.5 billion worth of mostly long only commodity assets.
"SARKO" CARRY TRADE
With the ECB money borrowed cheaply at just 1 percent, banks can buy government bonds with the same maturities from troubled euro zone sovereigns, exploiting the difference in yields which could amount to more than 400 basis points.
But banking analysts estimate no more than 100 billion euros would be used to buy government bonds from countries like Spain or Italy, in a muted response to the call by French President Nicolas Sarkozy for banks to load up.
Italian and Spanish government bonds did rise on bank buying expectations before the ECB tender, only to quickly wipe out gains. The benchmark 10-year Italian debt is back at 6.8 percent, near the crucial 7 percent which other countries were forced to seek external help.
Mid-sized or small banks in Italy and Spain are the most likely buyers of this "carry trade." Morgan Stanley estimates some 20-50 billion euros of Spanish bonds could be bought and there is potential for a similar amount in Italy which, to put it in context, must refinance about 150 billion euros of government debt in February-April alone.
With investors worried that banks are already over-exposed to government debt - plus Europe's banking regulator forcing banks to mark down their sovereign holdings - few banks were expected to aggressively take on the bet.
"In a deleveraging world, we doubt that this will be used in any meaningful way to buy sovereign bonds. This is also likely to be the case given the amount of scrutiny under which banks are regarding their sovereign exposures," said Nick Matthews, economist at RBS.
Banks are likely to have earmarked most of the cash they have taken to prepare for their own debt needs in the next three months. That should remove the risk that a bank could collapse due to a liquidity crisis and ease funding strains.
Banks face 725 billion euros of bank debt maturing next year, including a record 282 billion euros in the first quarter alone, according to Thomson Reuters data.
"It is really for the primary dealers, the regional banks and the rest of the banking sector, to ease the liquidity constraints they've got," said Bayram Dincer, analyst at LGT Capital. "To get to the end user demand, it must go via bank lending to the private sector."
Banks might start lending a little more freely again, a direct help for a euro zone economy which looks destined to slide back into recession.
UniCredit (CRDI.MI) and Intesa Sanpaolo (ISP.MI) said they plan to use proceeds to fund Italian industry and families. Italian banks took 116 billion euros of the ECB cash.
That should slow a pullback in lending that is evident across Europe, including at big banks like BNP Paribas (BNPP.PA), Societe Generale (SOGN.PA) and Commerzbank (CBKG.DE).
France's top banks are expected to use funds they took to increase lending or slow their deleveraging, rather than buy sovereign debt, French bankers said.
There is expected to be hefty demand at a second ECB offer of 3-year funding at the end of February. The risk, however, is that banks are becoming ever more reliant on the central bank.
To re-open wholesale funding markets, politicians must restore confidence in the underlying health of the euro zone and break the negative loop between banks and sovereigns.
One possible path to ease strains on the wholesale funding markets is the willingness of U.S. money market funds to come back to the European market as a result of the ECB operations.
U.S. money market funds, which form a giant $1.43 trillion industry, have been a key source of funding for European banks.
But their growing worries over the euro zone debt crisis have prompted them to reduce exposure to European banks - by a staggering 45 percent since end-May, according to Fitch Ratings.
Their exposure to French banks alone declined by 63 percent over the past month.
Starved of key funding from U.S. money market funds, European banks were forced to turn to the foreign exchange swap market to swap euros for dollars, causing a sharp widening of the dollar premium.
The premium for swapping euro LIBOR into dollar LIBOR over three months - known as the cross currency swap - stands at 133 basis points on Thursday, off a three-year high of 160 hit in November but ten times the level back in May.
(Additional reporting by Jan Harvey, Maytaal Angel and Mike Dolan, editing by Mike Peacock)