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How ECB Is Affecting Investment Markets?

2011 Dec 21

 

Today was announced very interesting news. The news is about the fact that ECB (European Central Banks) lends 489 billion of Euros to the banks. It is a really huge amount of capital that flows from ECB to the financial system of the European Union. And this news is extremely good for investment market and all bullish investors should be happy about such news. 

 

Let me explain why it is so favorable for investors with long investment positions. It was not a secret that everybody in investment and financial markets was waiting for ECB actions. And to be frank, everybody was waiting too long for strong actions. The most wanted serious action was direct buying of troubled countries’ sovereign debt. But Central Bank was denying such position for a long time saying about risk of inflation. However, inflation threat is not a worst thing that may wait in ahead.

 

Why it was important to buy sovereign debt? It is important in few ways. At first, it would mean an increase in money supply and that would bring more confidence in financial markets. Increase in money supply would set in motion investments in industry that were stopped because of unclear future conditions. And the confidence is now the main thing.

 

The second thing why it is important to by sovereign debts is an effect of those actions to the yields of bonds issued by countries that are facing the main difficulties. Increased demand for bonds would lower the yield in the markets and that would be huge help for countries as Italy and Spain. Also it would have positive effect on whole Europe’s financial market

 

But what all that has in common with ECB lending to the banks? The answer is simple. The effect is the same whether ECB is buying sovereign debt directly or through commercials banks. The thing is that ECB lends money for a very low interest rate and every bank will wish to receive such cheap funds. To receive those funds they must have collateral which is government bonds. So what banks can do is simple take loans from ECB at low interests and to buy government bonds (as Italy or Spain) that are paying much higher interests.

 

Of course such business model might be risky on the condition that Italy’s or Spain’s bonds aren’t riskless, but the thing is that many banks now may be balancing on the edge and such decision can be the best what they can make to make real and fast profit and get in a better shape. And of course, this won’t solve the problem of “zombies banks”, but let’s deal with the economy first. Industrial investments have to go on.   

 

 

By Rokas Lukosius

 

Read next article: Corporate Bonds and Government Bonds

 

Other articles you may like:

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Problems in Greece: Is It Going to End?

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Foundation of the Europe’s Financial Market





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