ECB to buy covered bonds

LONDON Thu May 7, 2009 4:18pm BST

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LONDON (Reuters) - The European Central Bank said on Thursday it would buy around 60 billion euros (53.5 billion pounds) of covered bonds and lend banks unlimited funds for up to 12 months among unconventional moves to unlock bank lending in the region.

President Jean-Claude Trichet also announced that the European Investment Bank, the EU's long-term lending arm, would be allowed access to ECB funding by taking part in the central bank's money market operations.

Trichet said the decision in principle to purchase euro-denominated covered bonds from euro zone banks did not amount to "quantitative easing," a term that refers to ways of increasing the money supply.

"The idea is to revive a market which has been very heavily touched, and all that goes with the survival of the market including spreads, liquidity and the depth of the market," he told a news conference. "We are not at all embarking on quantitative easing."

Covered bonds are backed by a pool of assets such as mortgage loans that remain on a bank's balance sheet. They are seen as safer than other bank bonds, because they give investors a claim on the bank itself and on the assets as well.

"Happy days are here again," said Ted Lord, managing director at Barclays Capital.

The move "is a very effective approach towards healing the financial markets in the euro zone. A healthy covered bond market supports two key areas necessary for economic recovery: the housing market and public sector infrastructure," he added.

Trichet said the ECB had focussed on covered bonds because they had been particularly hard hit by the financial crisis.

UNANIMOUS

Covered bond issuance dried up after the collapse of Lehman Brothers in mid-September 2008 led to fears of further bank failures. BNP Paribas reopened the market in January, but issuance has remained low.

The 60 billion euros is just under 10 percent of total outstanding liquid euro-denominated covered bonds measured by indexes and about four times the 15 billion euros of new traded issues year-to-date, said Ciaran O'Hagan, fixed-income strategist at SG CIB.

The equivalent issuance in 2008 totalled 96 billion euros.

"So you can see that the 60 billion is a significant amount," he said. "This is one step in the right direction, but they will follow up with more action."

But Julian Callow, an economist at Barclays Capital, said the amount was fairly small relative to the overall banking system: "It represents 3 percent of the Eurosystem's current balance sheet, and 5 percent in more normal times (like end-2006), and 0.7 percent of our estimate for 2009 euro area nominal GDP."

The ECB decision comes after months of deliberation about how far to go to support the economy. The Governing Council's decision to buy covered bonds was unanimous after "a very, very profound discussion on the assets and liabilities," Trichet said.

"This channel of financing of the economy was in a difficult situation," he said, adding that the Council had not taken such a decision on any other type of security.

At its next meeting on June 4 the ECB will determine the technicalities of how to implement the covered bond decision. "There will be nothing else ex-ante," Trichet said.

Trichet also said: "We will conduct liquidity-providing, longer-term refinancing operations with a maturity of 12 months." The first, to be announced on June 23, would be at the prevailing main refi rate, which the ECB earlier cut by 25 basis points to a new record low of 1.0 percent.

Banks could borrow all the cash they wanted at a fixed rate. Until now, refinancing operations were up to six months only. The ECB might set a higher rate than the refi at subsequent operations if necessary, he added.

"These decisions have been taken to promote the ongoing decline in money market term rates, to encourage banks to maintain and expand their lending to clients, to help to improve market liquidity in important segments of the private debt security market, and to ease funding conditions for banks and enterprises," he said.

The purchases would be "on the order of magnitude" of 60 billion euros, he said.

(Reporting by Natalie Harrison, Jane Baird, and David Stamp; editing by David Stamp)

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