ECB bond buys few bonds for second week

By DAVID McHUGH | December 23, 2011 | 10:10 AM EST

FRANKFURT, Germany (AP) — The European Central Bank held its bond purchases to a bare euro19 million ($24.8 million) this week.

The scant amount indicates that the bank has for now almost ceased the controversial program which has helped keep borrowing costs down for Italy and Spain.

It bought a minimal euro3.36 million last week. That makes two weeks of near-negligible purchases, following euro635 million the week ending Dec. 9 and euro3.66 billion the week ending Dec. 2.

The program has helped keep Italy and Spain from financial disaster from high borrowing costs. But the ECB says it is of limited amount and duration and that it is up to governments to cut their deficits and not wait for a central bank bailout.

THIS IS A BREAKING NEWS UPDATE. Check back soon for further information. AP's earlier story is below.

FRANKFURT, Germany (AP) — Banks from the 17 countries that use the euro stashed euro347 billion ($453 billion) overnight with the European Central Bank on Thursday, in another sign that Europe's debt crisis is still putting pressure on the banking system despite massive central bank support.

The figure announced Friday is the highest for 2011, topping euro346.4 billion earlier this month.

It's a sign of mistrust in the interbank lending market where banks raise operating funds, suggesting they are depositing money with the central bank at low interest rates because they are afraid to lend it to other banks — for fear they won't get paid back.

Europe is suffering from a debt crisis marked by concerns that heavily indebted governments such as Italy may be unable to pay off their bonds. That means trouble for banks because they typically hold government bonds.

The large deposits come despite Wednesday's massive central bank credit operation, in which the ECB let banks borrow as much as they wanted for up to 3 years. As a result 523 banks took euro489 billion, the largest ECB loan operation in the 13-year history of the euro.

The European Central bank has stepped up lending to banks to help them get through the crisis. Some of the banks are finding it extremely difficult to raise money elsewhere, so the bank steps in as lender of last resort, a typical role for central banks in times of turmoil.

The bank has refused to play the same role for governments by buying large amounts of their bonds, saying they must get their debts under control through their own efforts and not wait for a central bank rescue.

Italian 10-year bond yields remained elevated Friday at 6.90 percent, another sign that the markets remain fearful of a default by the eurozone's third-largest economy. Before the crisis spread to Italy, it was able to borrow at under four percent as recently as October 2010.

European governments are trying to win back the confidence of bond market investors by reducing deficits, a difficult job in a slowing economy. Italian Prime Minister Mario Monti won approval Thursday from the Italian Senate for euro30 billion in additional cutbacks and revenue increases.

Greece is working on a deal to cut its debt by making bondholders accept a bond exchange that would mean a 50 percent reduction in the value of their investments. The bondholders could accept that instead of the larger losses that would come from a disorderly default not agreed in advance.

A top ECB policymaker said in an interview published Friday that the central bank could use its power to create new money to buy financial assets if a deteriorating economy threatens the eurozone with deflation — falling prices.

Lorenzo Bini Smaghi, who is leaving office next week, was quoted by the Financial Times as saying he saw "no reason" why the bank could not use the technique, called quantitative easing by economists. Both the U.S. Federal Reserve and the Bank of England have used it after lowering interest rates to record low levels and finding that their economies still needed more stimulus.

The ECB's mandate is to provide price stability, so fighting deflation could be consistent with that. At the moment, however, inflation is running at 3.0 percent, well above the ECB's goals of just under 2 percent.