(Reuters) - The ECB's copious liquidity provision to banks this week should help them meet debt repayments next year but may have only a limited effect in freeing up shorter-term lending and even less in supporting peripheral sovereign bond markets.
The ECB cut its key interest rate by 25 basis points to 1 percent on Thursday, introduced three-year euro liquidity loans, halved the reserve requirement and widened the collateral base in an effort to ease funding strains for banks.
Morgan Stanley estimates 1.7 trillion euros of bank funding is due to roll over in the next three years. The European Banking Association says 650-700 billion euros of funding is due next year, most of it in the first half.
The original one-year financing operation (in 2009) encouraged banks to do carry trades and buy higher-yielding government bonds, but this time it's more about giving banks an alternative source of long-term funding, said one analyst at an investment bank, who declined to be named.
French President Nicolas Sarkozy said the ECB's move would enable banks to continue buying government bonds. Sovereigns depend particularly on domestic banks to buy bonds in the primary market but buyers of peripheral debt in the secondary markets have been scarce for months.
Bond markets have been all but closed to banks in the second half of 2011, with confidence in the sector waning on fears over exposure to the euro zone debt crisis.
ECB President Mario Draghi said the new liquidity measures put in place this week should help bank funding profiles as a large amount of bonds matured.
The aim of the longer loans was to keep the banking system liquid while it was under pressure due to the crisis, Draghi told a news conference on Thursday.
Much of the extra cash provided is likely to find its way back to the ECB's overnight deposit facility, at least initially, although a rise in excess liquidity may be capped by reserve requirements dropping by around 100 billion euros in January.
The central bank holds its first three-year tender on Dec. 21, replacing a planned one-year operation.
ICAP senior money market broker Kevin Pearce said it may take time for the ECB's actions to filterinto the market.
But I expect to see some positive effects from the latest measures in January. Knowing banks have liquidity for up to three years will boost confidence and therefore lead to an increase in interbank dealing, initially in the near end but hopefully progressing to longer maturities.
Fitch Ratings also said the ECB's offer of longer-term loans could encourage longer-term lending if enough firms sign up to the new programme.
Benchmark three-month euro Libor rates fell 3 basis points to 1.365 percent and the spread over overnight indexed swap rates (OIS) -- one measure of stress in the financial system -- was around 3 bps lower at 88 bps.
But other signs of stress showed little sign of easing with the Markit iTraxx senior financial credit default swap index 6 bps wider at around 300 bps and the subordinated equivalent 9 bps wider at around 530 bps.
However, BNP Paribas rate strategist Patrick Jacq expects this to change.
The impact will be an extension of the duration of liquidity, as well as a decline in stress on bank funding. Bank CDS are likely to decline a lot further...hand in hand with tighter OIS/BOR spreads.
Sentiment was not helped by rating agency Moody's downgrading the debt of BNP Paribas, Societe Generale , and Credit Agricole on Friday, citing deteriorating liquidity and funding conditions.
The ECB delivered what was already expected so we haven't seen a great improvement in sentiment, said Societe Generale credit strategist Suki Mann.
It just highlights how dire the situation is that they have to do these three-year tenders.