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European banks hoard cash despite Italian lift

In a more encouraging sign, Italy managed to sell €1.7bn of two-year loans at 4.5 per cent

European banks parked record amounts of cash at the European Central Bank (ECB) this week, in a sign that the massive pre-Christmas injection of liquidity into the Continent's financial system has failed to give banks the confidence to lend to each other.

The ECB revealed that financial institutions' deposits with the Frankfurt-based lender of last resort hit an all-time high of €452bn (£291bn) on Tuesday, beating a previous record of €412bn set on Monday. The fact that European banks are ploughing cash into deposit accounts at the ECB, which pays an interest rate of just 0.25 per cent, shows that fears of default in the sector remain elevated. Yesterday the euro fell to its lowest level against the dollar since January.

Last week, the ECB gave European banks €489bn in three-year loans at an interest rate of 1 per cent, in the hope that the banks would use these cheap funds to lend to financial institutions which have been shut out of the money markets.

There were also hopes banks would pass on the funds to struggling European businesses and households as well as governments that are finding it difficult to roll over their debts. The ECB funds are so cheap that any of these investment options would be profitable. But most banks have, so far, decided to hoard the money at the central bank, showing they are more concerned with maintaining large cash buffers than taking profit opportunities.

In a more encouraging sign, Italy yesterday managed to sell €1.7bn of two-year loans at an interest rate of 4.85 per cent, sharply down from the 7.8 per cent it had to pay last month. Some analysts interpreted this as a sign that European banks are, indeed, preparing to buy up eurozone periphery sovereign debt with their ECB loans. But others are sceptical. Simon Derrick of BNY Mellon said: "Is the two-year auction a good sign? Yes. Does it mean that this is how the banks are going to use this money from the ECB? I'd be very cautious about that."