May 17, 2010 / 4:59 PM / in 9 years

ECB moves swiftly to sterilize govt bond buying

FRANKFURT (Reuters) - The European Central Bank laid out plans to sterilize to its controversial government bond purchases on Monday, in a rapidly orchestrated move designed to quash fears the buy ups will lead to a surge in inflation.

The ECB also revealed 16.5 billion euros worth of bond purchases had been settled by last Friday, giving markets their first true glimpse of the ECB’s contribution to a $1 trillion attempt to resolve the euro zone’s debt crisis.

The ECB said it will start offsetting the purchases from Tuesday by taking one-week deposits from banks. It will offer an interest rate of up to 1.0 percent on any funds banks deposit, well above the 0.25 percent it offers on daily deposits.

The move is a bid to bolster its inflation fighting credentials having abandoned its long-held resistance to government debt buying.

“The ECB is trying to show that the purchases are not going to be inflationary,” said Barclays Capital economist Julian Callow. “It’s designed to assuage criticism, it’s a strong measure.”

The total bond purchases in the first week could be higher than the 16.5 billion euros declared on Reuters information page, given purchases typically take 2-3 days to settle.

Analysts at UniCredit said the 16.5 billion euros “should be just the first step and more purchases will likely be required to stabilize the market.”

“They should do another 70 billion to reach 10 percent of the total outstanding debt of Ireland: (82 bln) Portugal: (97bln), Greece: (258bln) and Spain (400 bln),” they added.

The ECB has kept details of its bond buying deliberately vague since it announced the plans last week, giving no hint on how much it will spend, how long the process could take or what type, or maturity, of bonds it is buying.

The move has received a mixed reception. Many analysts have welcomed it, pointing to the instant success it had bringing down yield spreads of trouble countries. However others, including ECB heavyweight Axel Weber, have criticized it for carrying inflationary risks.

As part of the new sterilization plan the ECB said it will allow banks to use the weekly deposits as collateral in its lending operations, a move that effectively gives them the option to reborrow the money again.

“With one hand you give and with the other you take, it’s not possible (to sterilize).. the result is still that the liquidity is there.” said ING analyst Carsten Brzeski.

The ECB said it will also repeat the operation next week and analysts now expect it to become a permanent feature.

“It will probably become a kind of rolling procedure whereby the volumes will increase every week,” said Unicredit’s Kornelius Purps.

Reporting by Marc Jones, Krista Hughes and Sakari Suoninen; Editing by Toby Chopra

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