FRANKFURT (MNI) – The European Central Bank will extend generous
liquidity provision via its open-market operations for as long as is
necessary and at least through the end of this year to 18 January, ECB
President Jean-Claude Trichet announced Thursday.

The central bank will continue to offer weekly MROs on fixed-rate,
full-allotment terms at least through the maintenance period ending
January 18, 2011, and for as long as needed, Trichet said.

The central bank will also carry out 3-month long-term fixed-rate
full-allotment refinancing operations in October, November and December,
he said.

The operations will be carried out at a fixed rate which is the
“same as the MRO rate prevailing at the time,” he added.

In addition to this, Trichet said the ECB Governing Council had
committed to offering additional three-month funds on September 30,
November 11 and December 23, when its 6-month and 12-month financial
operations mature. Those operations will have the same rate, he said.

Trichet said the non-standard measures were consistent with the
ECB’s mandate and that the central bank was doing everything necessary
to maintain price stability.

The ECB’s decision to extend its unlimited liquidity provisions
into next year had been widely expected after a number of Governing
Council members voiced their support for such a move.

The ECB first introduced its policy of unlimited liquidity
provision after the collapse of Lehman Brothers in the autumn of 2008
severely impaired interbank lending. In March this year, the ECB
attempted to return to the traditional auction method for 3-month
tenders but was forced by the Eurozone’s sovereign debt crisis to make a
sharp U-turn.

Nonetheless, the money market took a step towards normalization in
early July when banks repaid the ECB E442 in expiring 1-year funds and
borrowed back only around half that amount in other refinancing
operations, thus draining a significant volume of surplus liquidity from
the system and pushing up short-term market rates.

Although overall Eurozone money markets have continued to improve
since then, some banks, particularly in peripheral Eurozone countries,
remain cut-off from interbank lending. Demand for ECB liquidity was
still on the rise last month in some of those countries, including
Spain, Ireland and Greece.

The central bank is likely to tread very carefully in withdrawing
support as long as some banks in those countries remain dependent on the
ECB for cash. Starving peripheral banks of liquidity could spark a
credit crunch or even potential bank failures, taking the Eurozone’s
sovereign debt crisis to new heights and once again impairing European
interbank lending.

Nevertheless, more hawkish members on the Council may push for a
reduction of liquidity supply at the start of next year, given growing
concerns that the large amounts of surplus cash in the financial system
and low borrowing costs could pave the way for future crises. Council
member Axel Weber already called for a discussion in the first quarter
on resuming the ECB’s exit.

Trichet today did not give any indications about the potential
scope of liquidity provisions beyond the first quarter.

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