FRANKFURT Banks turned to the safety of the ECB as euro zone debt tensions intensified on Tuesday, hoarding over 90 billion euros at the central bank and borrowing heavily in its weekly funding handout.
Banks took 154 billion euros ($219 billion) in the ECB's weekly 7-day refinancing operation, well above the 134 billion traders had expected and the 120 billion they took last week.
Participation was also high with 230 banks taking funding compared to 185 last week, although it was within the range of recent months.
At the same time, banks parked 90 billion euros at the ECB overnight, the highest since February and a further sign of the reluctance hampering interbank lending markets.
While the hoarding is likely to be exaggerated by timing --deposits traditionally spike at the end of the ECB's reserves period -- traders said the recent intensification of the debt crisis was influencing behavior.
"It is a sign of the times," said one top money market trader, who asked to remain anonymous. "The reason it is so large is that people have front loaded reserves this period because of the situation."
FEAR AT PLAY
The euro zone debt crisis now appears to be sucking in Italy and Spain, two of the bloc's biggest economies.
The cost of insuring against default in Spain, Portugal and Greece hit a record high on Tuesday and 10-year bond yields in Italy, the euro zone's third-largest economy, shot above six percent for the first time since 1997, well above what bankers view as sustainable.
Euro zone bank shares also fell to a two-year low while the euro hit its lowest level against the dollar in four months.
Traders said that money markets remained relatively calm in terms of pricing but that the lack of activity was noticeable.
A top euro zone central bank money market expert said that Italian and Spanish banks were now facing tougher borrowing terms and scrutiny from their interbank peers but that they still had access to markets.
The money market curve -- an indication of what the ECB is expected to do with interest rates -- was also being distorted by the debt crisis, the previously quoted trader said.
"The curve has really flattened all the way out to May 2012, so it's almost like the pricing is for further rate cuts," he said. "There is fear at play here."
Economists say the flattening is not a true reflection of market expectations. Most ECB observers currently expect at least one further rate hike from the bank this year after it raised rates to 1.5 percent last week.
While this week's demand for 1-week ECB funding was far higher than estimated, banks took 68 billion euros in 1-month funding, slightly lower than expected and in line with last
The ECB also successfully drained the 74 billion euros of 7-day funds it needed to 'sterilize' the controversial government bond purchases it has made since May last year.
It also drained 75 billion euros overnight as it rebalanced markets ahead of the start of the new reserves period on Wednesday.
(Reporting by Marc Jones; editing by Ron Askew/Ruth Pitchford)