On Tuesday, Portugal's 10-year debt yield spread hit its widest

ECB offsets bond buys by draining 61 bln euros-UPDATE 1

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Thursday September 09, 2010 09:06:15 AM GMT
ECB/DRAIN-RESULT (UPDATE 1)* ECB drains 61 bln euros of weekly funds at 0.33 percent
* Banks attracted to deposits at ECB despite low rates
* Total liquidity stays close to previous levels

(adds detail, analyst comment)
FRANKFURT, Sept 7 (Reuters) - Banks accepted lowly returns on their cash from the European Central Bank on Tuesday, highlighting the appeal of the ECB's safe-haven status in the ongoing environment of money market tension.
The ECB comfortably attracted the 61 billion euros it needed from banks to offset the controversial euro-zone government bond purchases it has made since May.
It is also well below the 0.5 percent available on open markets, highlighting banks' preference to park cash at the ECB rather than lend it more profitably to peers.

The ECB takes seven-day deposits from banks on a weekly basis to match the amount it has spent buying government bonds -- a controversial tactic it turned to in May in a bid to calm the euro zone government debt crisis.

The purchases had an instant impact, bringing down the premium on the bonds of highly-indebted countries such as Greece and Portugal and allowing the ECB to scale back its buying dramatically.

But since then, spreads on sovereign debt have started climbing again. On Tuesday, Portugal's 10-year debt yield spread hit its widest since May against the benchmark German Bunds and the 10-year Irish spread marked a new euro lifetime high at 389 basis points.

But the rise of spreads has not persuaded the ECB to step up its bond purchases in a significant manner.

It spent only 173 million euros last week, up slightly from 142 million the week before, but still a fraction of the 16.5 billion it spent in the first week of the programme.

Analysts said the rising spreads reflect investor jitters about a deteriorating global economy and ongoing fears about euro zone debt levels.

"The market is starting to question again the solidity of growth in Europe and there is a search for a safe haven," said RBS economist Silvio Peruzzo.

"Given that we don't exactly know which banks need ECB funding, this has overall implications for the banking system in the weak countries, as well as for government bonds. This will take a while to get sorted."

In operations pushing money in the opposite direction, banks had slightly less appetite for ECB funds.

Banks' take in the ECB's weekly main refinancing operation nudged up to 153.7 billion euros from 153.1 billion in the prior week, but the rise was outweighed as appetite for one month-funds fell to 37.9 billion from 39.1 billion.

The ECB also drained 175 billion euros from money markets in overnight funds at the end of the reserve maintenance period, a point in the cycle when banks have to ensure their funding reserves are in order.

Interbank lending rates dropped to the lowest in six weeks, reflecting the ECB's announcement last week that it will continue to lend banks as much money as they want until at least mid-January. (Reporting by Sakari Suoninen; editing by Stephen Ni*****et)