(Adds further market reaction)
By David Milliken
FRANKFURT, Aug 23 (Reuters) - The European Central Bank’s first ever emergency injection of three-month funds was swamped with demand from banks on Thursday, but brought little relief to an interbank lending market beset by credit worries.
Euro zone banks snapped up the 40 billion euros ($54.2 billion) in funding after bidding for more than three times the amount on offer, as the ECB tried to reduce borrowing costs in one of the markets hardest hit by the global credit squeeze.
But indicative prices for three-month lending EUR3MD= were barely changed after the tender, quoted at a bid/ask spread of 4.65/4.70 percent, according to Reuters data, versus 4.65/4.71 percent before the announcement.
“The people who require the money still can’t get the money. The money is lying in the wrong place and wrong bank accounts. The people who have it aren’t lending it out,” said a money market trader at a large bank.
The ECB is the ultimate source of money for euro zone banks, and its three-month tenders are normally aimed at getting funds to smaller banks which do not take part in its weekly auctions.
Small banks have found it hard to borrow money for longer than a week because recent bailouts at two German banks, IKB and Sachsen LB, have scared away lenders afraid of getting caught in another bank’s hidden exposure to U.S. subprime mortgages.
This has pushed official three-month interbank rates EURIBOR3MD= to their highest levels since May 2001.
Banks bid for a total of 125.8 billion euros in funds, much more than the 78.7 billion euros banks bid for at the ECB’s last regular allotment of three-month funding on July 25.
The ECB allotted funds at an average rate of 4.61 percent, a fat premium over the lowest successful rate bid of 4.49 percent. At least one bank offered to pay 5.00 percent for ECB money.
A German trader said money changed hands at about 4.72 percent after an initial dip, as British and Swiss banks sought to get three-month euro funding.
But an Italian trader was more hopeful that the ECB funding would ultimately feed through into lower market rates. “The market lacks confidence and that isn’t something that is going to return in one session,” he said.
The three-month tender follows record ECB intervention in the overnight and one-week segments of the euro zone’s interbank lending markets earlier in the month, which was successful in reducing shorter-term borrowing costs.
The ECB’s next regular tender of three-month financing is scheduled for Aug. 29, when 50 billion euros is available to replace a similar sum that falls due the day after.
Some economists think banks’ difficulty in finding funds — which can ultimately raise consumer and business loan costs — might dissuade the ECB from raising official rates at its next meeting on Sept. 6.
“Today’s operation has perhaps not reduced the pressure ... to the extent the ECB will have hoped,” said Andy Chaytor, rate strategist at Royal Bank of Scotland.
“Our view is that this has increased the chances that the ECB will ultimately remain on hold at their next meeting, as it now looks less likely that the money markets will have calmed down sufficiently,” he said.
But others expect the ECB to draw a clear distinction between the problems faced by some banks and the overall strength of the euro zone economy, which just two weeks ago led the ECB to stress again the risk of higher inflation.
When it announced the three-month tender on Wednesday, the ECB also reminded markets of its Aug. 2 policy stance.
“(This) was intended primarily to inform markets that yesterday’s surprise announcement was not connected with a monetary policy signal, i.e. that the ECB was not saying anything new with the repo announcement or operation,” said Julian Callow, chief European economist at Barclays Capital. (Additional reporting by Kerstin Leitel in Frankfurt and Anooja Debnath and Rahul Karunakar in Bangalore)