Money markets ecb collateral expansion clears way for cash grab

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* Collateral expansion will let banks take more ECB cash* Seven central banks approve the additional measures* BoE expands quantitative easing programmeBy Kirsten DonovanLONDON, Feb 9 An expansion of the assets eligible as collateral in the European Central Bank's financing operations clears the way for banks to grab more three-year cash at the end of the month and should further ease financing strains. The ECB approved proposals from seven national central banks, including those of Spain, Italy and Portugal, temporarily to accept additional credit claims as collateral. The new rules will apply at the ECB's second offering of three-year loans, on Feb. 29, when demand is expected to be similar to the near half trillion euros taken up at the first, in December. The operations are aimed at easing a bank funding squeeze as debt repayments fall due, with bond markets all but closed to banks on fears over exposure to the sovereign debt crisis."If you can effectively pledge the kitchen sink you could see a fairly significant take-up," said Rabobank rate strategist Richard McGuire. "But while it allows for easy access it doesn't address the heart of the problem."That, McGuire said, was not liquidity but that some banks were using the cash, either temporarily or longer-term, to buy their country's debt - the "carry trade", in which an investor borrows at a low interest rate to buy higher-yielding assets.

"That provides support to the peripheral issuers but sees those banks become more vulnerable to a possible turn in sentiment down the line," he said. Meanwhile, in an effort to prop up a fragile economic recovery, the Bank of England decided to inject another 50 billion pounds into the UK financial system through its quantitative easing asset purchase programme. Both the ECB and the BoE left their key interest rates unchanged at 1.0 and 0.5 percent respectivelyMuch of the funding from the ECB's first three-year operation has been earmarked for repaying maturing debt but some banks are putting the funds to work in the meantime.

Initial signs are that while northern European banks are, for now, channelling the money into safer places such as German government bonds, repos and the ECB's vaults, southern European banks, especially in Spain, have dived back into their own countries' sovereign issuance, supporting the euro zone peripheral bond markets. Expectations of a large take-up at the second such tender at the end of February have spiralled with market talk it could be as much as 1 trillion euros. However, many analysts take a more modest view and a Reuters poll published on Monday saw an allocation of 400 billion euros , higher than in a similar survey a week earlier. Deutsche Bank said that if take-up was close to its own 500 billion euro estimate this would greatly help sentiment in financial markets."It would still present a powerful tool for market sentiment as the new money which could be used for carry trades, providing a cushion for bank refinancing and to buy back own debt, could be almost double the December (operation)," the bank's analysts said in a recent note.

LENDING The cash is gradually helping free up money market lending, although the market remains far from functional. ICAP senior broker Kevin Pearce said there had been a "marked pick up" in trading over the last couple of weeks although much of it had been in certificates of deposit - tradeable debt instruments issued by banks bearing a set rate of interest - rather than straight cash."Although deals are still struck on a name specific basis, there are definitely signs that lending restrictions are being lifted and a wider spectrum of names being consider," he said."The next (three-year operation) should facilitate this even further, especially if take-up is towards the top end of the ranges mentioned recently."ECB President Mario Draghi said that although credit conditions tightened in the last quarter of 2011, that did not take into account three-year funds injected into the system at the end of December, the effects of which were still unfolding."The ECB seem to be willing to maintain a "wait and see" mode," said Annalisa Piazza, market economist at Newedge Strategy.