ECB Mulls Restarting Covered-Bond Purchases

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September 26, 2011, 11:35 AM EDT By Gabi Thesing and Esteban Duarte

Sept. 26 (Bloomberg) -- European Central Bank policy makers are likely to next week debate restarting their covered-bond purchases along with further measures to ease monetary conditions, a euro-region central bank official said.

The reintroduction of 12-month loans to banks will also be discussed at the ECB’s Oct. 6 policy meeting, said the person, who spoke on condition of anonymity because the information is confidential. Interest-rate cuts are likely to be discussed, though they are not on the current agenda, the official said.

The euro rose half a cent against the dollar to as high as $1.3543. Yield spreads between covered bonds and interest-rate swaps tightened. A spokesman for the Frankfurt-based ECB declined to comment.

European officials are under pressure to intensify efforts to contain their 18-month debt crisis as Greece teeters on the brink of default. U.S. Treasury Secretary Timothy F. Geithner called on governments to unite with the ECB to beef-up the capacity of their 440 billion-euro ($594 billion) bailout fund, warning that failure to act threatened “cascading default, bank runs and catastrophic risk” for the global economy.

With money markets tightening, the official indicated the ECB is more likely to try non-standard measures first before resorting to rate cuts. It wouldn’t make sense to re-widen the rate corridor by cutting the deposit rate without also reducing the benchmark rate, the official said. The ECB raised its key rate twice this year to 1.5 percent.

‘Appropriately Accommodative’

ECB rates remain “appropriately accommodative,” ECB council member Athanasios Orphanides from Cyprus said in New York today.

The ECB purchased 60 billion euros of covered bonds in a one-year program that expired in June last year and was aimed at freeing up banks’ balance sheets and encouraging lending during the region’s worst recession since World War II.

ECB council members Ewald Nowotny from Austria and Luc Coene from Belgium, attending the World Bank and International Monetary Fund annual meetings in Washington over the weekend, said the central bank may look at stepping up efforts to boost growth as soon as next month. They both identified renewed 12- month lending to banks as an option. The ECB last offered a 12- month loan in December 2009.

“For liquidity, we are there” and “ready to do what is needed,” ECB Executive Board member Lorenzo Bini Smaghi said in New York today. “We need to reassure the markets.”

Bond Purchases

As euro-area politicians procrastinate over how to solve the crisis, the ECB was forced to resume buying government bonds on the secondary market last month to reduce borrowing costs in Italy and Spain.

The 2.5 trillion-euro market for covered bonds -- assets backed by mortgages or public-sector loans -- underpins much of Europe’s real estate lending, which almost ground to a halt in the wake of Lehman Brothers Holdings Inc.’s collapse in September 2008.

Tensions have reemerged, driving to a record the risk premium investors demand to buy the securities. Investors are demanding 237 basis points of extra yield above the safest government bond, according to Bank of America Merrill Lynch indexes. That’s one basis point below a Sept. 22 record and compares with 201 basis points a month ago.

Yield spreads between covered bonds and interest-rate swaps, the benchmark used to price the notes, tightened between 3 and 5 basis points on news of the possible ECB purchases, said Armin Peter, head of covered bond syndicate at UBS AG in London.

“The ECB sees the covered bond as some kind of silver bullet for funding problems at European banks,” said Bernd Volk, head of covered-bond research at Frankfurt-based Deutsche Bank AG. “Since the market is now in trouble, it is the right timing to put this tool on the table. It would have positive effects on the spreads and trigger new issuance.”

Banks have sold 14.5 billion euros of covered bonds so far this month, according to Bloomberg data, the lowest amount sold in that September period since 2003.

The official said ECB policy makers haven’t decided on the size of the potential new covered-bond purchase program.

--With assistance from Timothy Homan in New York. Editors: Matthew Brockett, John Fraher

To contact the reporters on this story: Gabi Thesing in Washington at gthesing@bloomberg.net; Esteban Duarte in Madrid at eduarterubia@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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