January 12, 2012 / 8:31 AM / 8 years ago

UPDATE 4-ECB sees "substantial" effect from cheap loan offer

* ECB holds interest rates at 1.0 pct

* Says 3-year liquidity offer helping banks substantially

* Sees signs of economic stabilisation, uncertainty high

* Spanish, Italy bond auctions buoyed after ECB money flood

By Sakari Suoninen and Eva Kuehnen

FRANKFURT, Jan 12 (Reuters) - The European Central Bank said on Thursday its flood of cheap 3-year loans is helping banks and supporting morale across the euro zone, but it still left the door open to further interest rates cuts.

It also said the bloc’s economy was showing some signs of stabilisation in activity deep down, although it faced risks.

The ECB left rates on hold at 1.0 percent at its first policy meeting of 2012, pausing to assess the impact of back-to-back cuts and a slew of other measures it took late last year that are showing signs of helping fight the euro zone crisis.

ECB President Mario Draghi told a news conference the first of two 3-year cheap funding operations the ECB announced in December was helping and that a second change to borrow in February should also prove popular.

“The extensive recourse to the first three year refinancing operation indicates that our non-standard policy measures are providing a substantial contribution to improving the funding situation of the banks, thereby supporting financing conditions and confidence,” Draghi told a post-meeting news conference.

Draghi’s comments on seeing tentative signs on stabilisation in the economy after the record liquidity offer boosted the euro .

To help fight the euro zone crisis, the ECB provided banks in December with nearly half a trillion euros of cheap 3-year money.

French President Nicolas Sarkozy has urged banks to use the loans to buy sovereign bonds of euro zone strugglers and strong debt auctions in Spain and Italy on Thursday suggested some may be doing that, with analysts saying abundant liquidity helped support demand.

Banks remain very reluctant to lend to each other, so the ECB’s action has helped keep the system working although there is less evidence that the money is making its way into the real economy.

Commercial banks’ overnight deposits at the ECB have hit successive all-time highs since the 3-year funds were dispersed, though Draghi said there were some signs the money was finding its way into the economy.

“The more time passes ... the more we see signs it has been an effective policy measure,” he said. “This decision has prevented a credit contraction that would have been ... much, much more serious.”

“By and large, the banks that have borrowed the money from the ECB are not the same (as those) that are redepositing the money with the deposit facility of the ECB,” Draghi added.

He also said the bank still stood “ready to act” again on rates.

“This suggests that the ECB could cut rates further to 0.75 percent if financial tensions were to escalate,” said Berenberg bank economist Holger Schmieding. “The ECB identified such tensions as the major risk to the economic outlook.”

READY TO ACT

The ECB’s decision to leave rates on hold after cuts in November and December - taken unanimously - was in line with market expectations.

“(The) monetary stance remains and will remain accommodative,” Draghi, adding: “...uncertainty is very high and we will monitor all the developments and will stand ready to act.”

He declined to label 1 percent as a floor for ECB rates.

Analysts also highlighted Draghi’s use in his opening statement of the phrase “a very thorough analysis of all incoming data and developments over the period ahead is warranted”, which they said could allow for further rate cuts.

Alongside the extraordinary liquidity to banks, the ECB has eased its collateral rules and kept buying Italian and Spanish government bonds although it continues to baulk at doing so to the more dramatic extent which some policymakers have urged.

Spanish and Italian yields both fell sharply at Thursday’s auctions and Spain shifted twice the amount of bonds it expected to.

“Is this (bond auction result) evidence that this trade (banks using ECB 3-year money to buy bonds) is in place or not. We frankly don’t have enough elements to say that,” Draghi said.

The euro zone economy continued to face high uncertainty, he added, though he pointed to some signs of stabilisation.

At his first meeting at the helm in November, Draghi said the euro faced a mild recession. He did not repeat that stance on Thursday.

“Ongoing financial market tensions continue to dampen economic activity in the euro area, while, according to some recent survey indicators, there are tentative signs of stabilisation activity at low levels,” he said.

GREECE DEAL UNIQUE

Draghi said the ECB was pleased that euro zone leaders had confirmed the involvement of private creditors in the second Greek bailout was “unique and exceptional”.

Greece’s prime minister held crunch talks with the head of a group representing private sector banks on Thursday, as officials said negotiations on a voluntary swap of bonds to lighten the country’s debt burden entered the final stretch.

But senior European bankers say talks about private sector creditors paying for part of a second Greek bailout are going badly, raising the prospect that euro zone governments will have to increase their contribution to the aid package.

ECB policymaker Athanasios Orphanides last week called for a reversal of PSI. Draghi did not do the same. He also repeatedly dodged the question whether the ECB could accept losses on its holdings of Greek sovereign debt.

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