The European Central Bank (ECB) yesterday injected €529.5 billion (Dh2.6 trillion) into Europe's banking system, close to the expectations of the financial markets worldwide.
Most European stock indices reacted positively to the news as the Dow Jones opened above the 13,000 mark. The key UK benchmark, FTSE 100, remained subdued as Bank of England governor Mervyn King warned parliament of a bumpy road ahead for the UK economy and expressed doubt if the central bank would sanction another round of quantitative easing.
Economists and market analysts said the pumping of fresh liquidity into the market yesterday is likely to percolate across the world markets and sustain the rally that began with the first round of the longer-term refinancing operation (LTRO) which the ECB introduced last December.
"The latest round of LTRO has taken a significant level of uncertainty and liquidity concerns from the financial market. The new liquidity is going to support risk appetite which could encourage more issuance on capital markets," said Alessandro Magnoli Bocchi, Chief Economist of Kuwait China Investment Company in Abu Dhabi yesterday.
The new money pumped into the European financial system is expected to have a direct impact on European banks and the overall cost of borrowing in the euro area. Banks are expected to use a significant part of these funds to buy their respective national sovereign debt, effectively bringing down their borrowing costs. Recent figures from the ECB show that Italian and Spanish banks increased their holdings of sovereign bonds by 13 per cent and 29 per cent respectively between December and January.
While economists and analysts differ on the long term efficacy of the cheap money policy in bringing about sustainable economic recovery, all agree that it is certainly a big relief to financial markets and the European banking system that are starved of liquidity.
As some economists warned that European banks are likely to become cheap money junkies, others said the immediate concern is a liquidity lifeline and the ECB is right in addressing it through LTRO II.
"There can be endless debate on the extraordinary measures adopted by central banks across the world to boost liquidity in the financial system.
"There are concerns about the long term inflationary impact of these huge injections of money. But the immediate concern is to relieve the financial system from a liquidity crisis. Obviously there will be a tightening cycle in the future," said Paul Volcker, former Federal Reserve Chairman commenting on the second liquidity boost by the ECB.
European banks in the region said new funds from the ECB will ease liquidity pressures on their balance sheet which will allow them to lend more in the region. "The ECB action has a big impact on the balance sheets of European banks. It has eased a great deal of pressure on European banks which gives them the opportunity to look at some of the high yield investment opportunities from the Middle East region," said Simon Eedle of Credit Agricole CIB, Bahrain.