It was big bazooka time in Frankfurt this morning. The ECB met huge demand for its 3 year cheap money all 'secured' on some dodgy collateral. The Eurocrats are hoping the banks will rush out and buy PIGS sovereign debt yielding 5% plus tempted by the huge profit this carry trade offers if the sovereign repays in 3 years time!
So this carry trade involves taking on a lot of risk something banks have been keen to reduce recently. Merkel's whizzo haircut threats does not help sentiment either. The banks may therefore choose to use their new found Euros to repay their existing debt when it falls due and shrink their balance sheet.
The market reaction, raising the rate on Italian bonds by around 10 bps after the announcement today indicates the latter is what the markets think banks will do. We will have to wait and see as this latter move would also signal a bank in trouble.
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The funds will be lent at the average of the ECB's benchmark interest rate, which is currently at a record low of 1 per cent, the central bank said. We can't stop them, if this is their ruling.
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