* Lending to firms up slightly in Jan after record fall in Dec
* Growth pace continues to decline y/y, reaches 1.3 pct in Jan
* Bank deposits fall further, bad loans up 18 pct y/y (Adds details on cost of credit, bad loans, comments from bank official)
By Valentina Za
MILAN, March 8 (Reuters) - The flow of bank loans to Italian companies improved slightly in January after recording the sharpest monthly fall on record in December but its annual pace of growth still slowed sharply.
Data from the Bank of Italy on Thursday showed private sector deposits with banks fell for the fourth month in a row, dropping 0.8 percent in January.
Loans to non-financial companies stood at 899.3 billion euros in January, up slightly from December, when they had contracted by a record 21 billion euros amid severe funding strains on Italian banks.
The liquidity situation has since improved due to massive injections of cheap longer-term funds by the European Central Bank. Italian lenders have taken a total of 255 billion euros in three-year financing at two ECB tenders on Dec. 21 and Feb. 29 but the key for the broader economy is whether they lend that on to companies and consumers to get growth going again.
In annual terms, bank lending to companies rose but the pace of growth halved in January from a month earlier to 1.3 percent.
The overall annual growth rate for lending to the private sector - which also includes households - declined to 1.6 percent from 2.3 percent in December.
Private sector deposits with Italian banks fell 0.8 percent, extending a contraction started in October.
“Deposits, our structural and cheaper source of funding, have been declining for a while,” said an executive at a large Milan-based lender, declining to be named. Funding difficulties “have led us to be selective in lending, also because bad loan (growth) runs at 20 percent,” he said.
Bank of Italy data showed the annual growth pace in bad loans slowed in January to 17.9 percent from 19.5 percent.
Bonds issued by Italian banks - which have been able to continue to place debt with their retail clients even as wholesale markets froze due to the debt crisis - rose at an annual pace of 16.4 percent in January, up from December.
The average cost of loans to companies fell slightly in January to 4.06 percent, mirroring an ease in market tensions following the first ECB’s liquidity injection.
The drop, however, was driven by lower interest charged on loans larger than 1 million euros, the Bank of Italy said, while the cost of smaller loans continued to rise to reach 5 percent.
Banks’ funding costs are tied to Italian bond yields which have declined sharply this year, especially on shorter maturities. The yield spread between 10-year Italian and German bonds fell below 300 basis points for the first time since early September on Thursday.
House mortgage rates continued to rise and stood on average at 4.6 percent in January. The interest charged on consumer loans soared to 9.9 percent from 9.1 percent a month earlier.
Italian households are among the least indebted among advanced economies. (Additional reporting by Luca Trogni; editing by Patrick Graham)