June 30, 2010 / 10:15 AM / 9 years ago

UPDATE 1-Banks borrow less than expected from ECB, easing fears

* ECB three-month loans fall short of expectations

* Take-up helps allay concerns about bank finances

* Risks upward pressure on market interest rates

(Adds details, quotes, reaction)

FRANKFURT, June 30 (Reuters) - Banks borrowed less than expected from the European Central Bank in a key funding operation on Wednesday, easing fears about their ability to cope with the repayment of close to half a trillion euros in 12-month funds on Thursday.

The ECB said 171 banks borrowed 131.9 billion euros ($161.4 billion) over three months at a flat rate of 1 percent, below expectations in a Reuters poll for demand of 210 billion euros. [ID:nLDE65R1NZ]

The amount is still the highest ever borrowed in a three-month operation but pales beside the 442 billion euros of one-year money which 1,121 banks must repay to the ECB on Thursday.

The low take-up should help ease concerns about bank finances, which have rocked stock markets this week, but also raises the risk of market rates ticking higher as liquidity supplies may recede.

European shares gained on the news while the euro rose across the board EUR= and yield spreads for Spanish and Italian government bonds eased. [ID:nLDE65T0VC] [ID:nLDE65T0IO]

“All in all it is a positive signal for the European banking system,” said UniCredit fixed income strategist Kornelius Purps.

“This is, in my view, why we see the reaction in the market... some of the fear is being priced out of the fixed income universe. Nevertheless, still 170 banks see it as a viable option to get financing from the ECB at 1 percent for only three months, so we’re not out of the woods.”

Banks in countries including Greece, Spain and Portugal are increasingly dependent on the ECB for funding as they struggle to borrow from others due to concerns over debt and public finances. [ID:nLDE65M1TF]

The rate the ECB is charging is above current market rates of 0.767 percent EURIBOR3MD= but analysts said bank-to-bank costs may rise if there is a large net drain of funds.

Banks have the chance to borrow unlimited six-day funds at a special operation on Thursday and market participants said the results of this operation would also be fundamental to gauging the extent of bank funding stress.

“We still have the six-days to be filled, it’s about the total,” one euro zone money market trader said.

“In my opinion there will be enough over-liquidity to keep rates around current levels ... but we will see tomorrow.”

Commerzbank analyst Christoph Rieder said there would be a net outflow of 269 billion euros from euro-zone money markets on Thursday, about a third of the ECB’s outstanding loans, without including the results of the six-day operation.

“This is a level where upside pressure on overnight rates could be building,” he said.

For a graph of ECB lending to banks, please see: here (Reporting by Krista Hughes, editing by Mike Peacock)

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