December 8, 2016 / 4:15 PM / in 8 months

UPDATE 1-ECB to lend out bonds for cash to avoid market squeeze

3 Min Read

* ECB and 6 central banks launch cash-for-bond scheme

* Lending against cash capped at 50 bln euro cap

* Lending rate set at -0.70 bps or lower (Adds detail)

By Francesco Canepa

FRANKFURT, Dec 8 (Reuters) - The European Central Bank will start accepting cash rather than just bonds as collateral for lending out some of its huge pile of government debt, it said on Thursday, to ease stress in a key short-term funding market.

The ECB's purchases of 1.2 trillion euros worth of government bonds, aimed at boosting the economy, have inundated the euro zone's financial system with cash.

But they have also deprived it of high-quality government bonds, the most used collateral for repurchase agreements, which are vital to finance trading and transmitting the ECB's stimulus to the euro zone's struggling economy.

Thursday's decision, which confirms an exclusive report from Reuters last month, is aimed at making it easier for banks to borrow some of the government debt the ECB has bought.

By doing so, the ECB hopes to oil the repo market, where financial firms lend to each other against collateral.

The ECB and the Bundesbank own more than a quarter of all German government debt, the most coveted collateral for repo. Funds pay up to 1.5 percent to borrow a 10-year Bund, up from some 0.40 percent a year ago, according to Icap data.

Apart from the ECB, the central banks of France, Spain, Belgium, the Netherlands, Ireland and, crucially, Germany will take part in the new cash-for-bonds scheme, which will start on Dec. 15.

The devil might be in the detail. First, only 50 billion euros out of the total 1.2 trillion euros will be available for lending against cash.

Second, the bonds will be offered at a rate of at least -70 basis points against cash, seen by some in the market as punitive.

"50 billion euros is not that big," Peter Schaffrik, chief European macro strategist at RBC Capital Markets.

"If you look at the rate they make it available at, it's relatively expensive and it should not really allow general collateral to become much cheaper." (Reporting by Francesco Canepa; Editing by Tom Heneghan)

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