European Central Bank Loans Euro Banks $712 Billion
The European Central Bank provided euro zone area banks with another 530 billion euros ($712 Billion) in cheap loans on Wednesday. The European Central Bank (ECB) hopes that the low interest loans that it gave to 800 euro zone banks will give the euro zone economies a boost and lower the borrowing costs of troubled countries like Spain and Italy.
The 530 billion euros in loans are part of the ECB's second round of longer-term refinancing operations, or LTRO, and were much bigger than last year's LTRO of 489 billion euros to 523 banks. The first round of funds that the ECB injected into euro zone banks was credited with preventing a credit crunch that threatened to bring down some of Europe's biggest banks. French banks in particular were the subject of many rumors concerning a possible funding crisis.
The earlier round of cheap loans from the European Central Bank may have also been responsible for rising equity prices and falling borrowing costs for Italy and Spain. French President Nicolas Sarkozy had suggested that the banks use some of the funds to buy the debt of euro zone countries. His suggestion gave birth to the so called “Sarkozy trade” of banks using low interest loans from the European Central Bank to buy high interest debt from troubled euro zone countries.
Euro zone banks have profited from the interest rate spread between their ECB loans and the sovereign debt that they purchased. For their part, countries like Italy and Spain were able to raise funds at a lower cost than if they had depended solely on demand from the market. It has also given the governments breathing room in order to deal with the underlying problems of the euro zone sovereign debt crisis without having to worry about short term funding.
European leaders hope that the latest cheap loans will continue to hold their borrowing costs down. Because of the European Commission's forecast that the euro zone economy will shrink 0.3 percent this year, euro zone leaders will also be hoping that a good deal of the funds are also injected into their countries' economies in the form of loans to businesses and consumers. European Central Bank President Mario Draghi said that the banks that are receiving the 530 billion euros of funding need to increase their lending to businesses and consumers so that the euro zone can economies can start to grow again.
Although the European Central Bank's longer-term refinancing operations have served their purpose in shoring up the euro zone's banking sector and lowering the borrowing costs of countries like Italy and Spain, there is growing concern that euro zone banks could grow dependent on the ECB's cheap loans. Because of these concerns, this might be the last round of longer-term refinancing operations by the ECB. Still, the first LTRO was largely a reaction to a crisis facing the euro zone banking sector, so if things take a turn for the worse in Europe the ECB will be under intense political pressure to act again.
Traders who believe that the 530 billion euros of cheap loans will benefit the euro zone might want to consider the following trades:
- Euro zone banking stocks like Spain's Banco Santander (NYSE: STD) will benefit from the low interest funds being poured into euro zone banks.
- The Spanish and Italian stocks that make up the iShares MSCI Spain Index (NYSE: EWP) and the iShares MSCI Italy Index (NYSE: EWI) ETFs could post significant gains if the banks of Italy and Spain put more money into the pockets of consumers and businesses.
Traders who believe that the euro zone banks and countries like Italy and Spain are becoming to dependent on low interest loans from the ECB may consider alternative positions:
- Short euro zone banking stocks like Banco Santander (STD) and Deutsche Bank (NYSE: DB). The banks' stock prices could benefit from the funds in the short term but if this is really the last round of cheap ECB loans, their share prices could drop back down within months.
- The ProShares UltraShort MSCI Europe (NYSE: EPV) and the ProShares UltraShort FTSE/Xinhua China 25 (NYSE: FXP) ETFs could also move higher if the relief provided by the cheap funding proves to be temporary. Europe's economy would suffer and the drop in European demand could limit Chinese economic growth.
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