Hamish McRae: How the ECB's big bazooka saved the eurozone's banks – and may again

A central bank's job is to meet a liquidity crisis by producing unlimited cash
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The Independent Online

Today we will know how many more euros the European Central Bank has pumped into the eurozone's banks in this second stage of its Longer-Term Refinancing Operation. Just before Christmas, it issued just under €500bn of three-year loans at 1 per cent interest and expectations this time range from some €250bn right up to €800bn. In December, LTRO – the brainchild of the new Italian leader of the ECB, Mario Draghi – was credited not just with saving some banks from going under but with turning round the position of several weaker eurozone countries, including, ahem, that of Italy.

The idea was, and is, to enable banks to fund themselves when they cannot raise enough deposits to do so. Banks in the weaker eurozone countries have seen deposits walk out the door. Over the past six months, Greek banks have lost nearly 13 per cent of their deposits, Portuguese and Irish banks 9 per cent, and Italian banks 8 per cent. By contrast, deposits in core countries, notably Germany and the Netherlands, have gone up as people and businesses switch their funds to what they perceive as safer banks and perhaps safer euros, too.

But if the idea was to enable banks to keep lending to customers, in practice a lot of the money ended up in eurozone sovereign debt. It makes huge sense for a bank if it can borrow at 1 per cent and earn 5 per cent on it by buying three-year Italian bonds. Indeed, I heard a story that the French government was in effect ordering at least one of its banks to use the LTRO money to buy French debt – the phone call strongly advising them to do so was made.

Actually, this was what the ECB intended – not the phone call but the fact that banks would find it profitable to buy sovereign debt. The French member of the ECB board, Christian Noyer, said in December: "What we decided yesterday in the governing council of the ECB was to use our bazooka... so that banks can continue to do their job, continue to provide credit to the economy and... buy sovereign debt."

The effect was positive, for the ECB's action not only helped the banking system and bond markets but seems to have given a boost to business sentiment generally. Share prices went up, businesses reported higher confidence, and consumers in some countries, notably Germany, seemed to have been loosening their wallets and purses a little.

So the question now, aside from the scale of the take-up, will be whether this second wodge of money will give a further boost to Europe, or whether the more often the medicine is administered, the less effective it seems to become. This seems to have been the case with our own quantitative easing: the first bout had a substantial impact, particularly on the housing market, but subsequent tranches have been less effective.

There are further concerns. One is inflation. Print the money and sooner or later it seems to show up in higher prices, as has happened here in the UK. The ECB has been more effective than the Bank of England in meeting its inflation target, and deserves credit for that. But the latest German inflation figures are a little worrying and the general perception is that the ECB's monetary policy is now too loose for Germany.

That concern goes back to the fundamental flaw in the eurozone: that the very different economies need different monetary policies and that the "one size fits all" interest rate means that some parts will always have the wrong one.

But all that is in the future. Today the ECB will keep the money flowing. The defence is that this is classic central banking stuff: the job of a central bank is to meet a liquidity crisis by producing cash without limit. But this does not fix the solvency crisis of fringe Europe, which will surely get worse before it gets better.

We need clever immigrants

The immigration/skills issue has come up again, as it will continue to do. Following last week's figures which showed that net migration remains at 250,000 a year and this week's report from the Home Office's Migration Advisory Committee, there have been several commentaries on the need for imported skills.

Thus the CBI commented that it was "good that the MAC has said the cap on skilled migrant workers should stay at its current level for the coming year... there is little evidence of skilled migrant workers undercutting the labour market".

But as this is a debate that can generate more heat than light, a welcome to some work by the National Institute. It has just surveyed two industries, aerospace and financial services. It found that employers needed to recruit outside the EU to fill key skills – particularly the mixture of technical, language and soft skills – and there was little evidence that these could be developed easily in the UK.