ECB Winding Down or Winding Up?

A couple of ECB officials have indicated that when the extraordinary liquidity provisions expire at the end of the end of the year, they will not be renewed. Officials drew comfort in the recent news that the stock of bank loans accelerated in August. That European banks are weaning themselves off the special liquidity provisions is likely reinforces the exit strategy, which Trichet will likely be questioned about after the ECB meeting Thursday.

Last week, European banks chose not to roll over roughly 80 bln euros despite the unlimited amount they could have had from the ECB for three months. Money market rates have generally risen. This should not be seen as a sign that the situation has normalized in Europe. We would note that banks on the periphery are still in need.

The bond market also appears to have required great ECB support. Last week the ECB bought more European bonds than it has in more than 3-months. It's 1.38 bln euro purchase is roughly 10-times larger than the prior week's purchases. It will offer 63.5 bln of term deposits tomorrow to neutralize the cumulative bond purchases. This will not be problematic, but as the amount approaches 80 bln, judging from the bidding for the term deposits, some strains are likely to appear and this will be reflected in not mopping up the full amount for a week or so at a time.