* Sources cite political, technical, legal hurdles
* Squeeze looms at end of March
By Francesco Canepa
FRANKFURT, March 6 The European Central Bank is
unlikely to beef up its lending of government bonds when it
meets on Thursday, sources have told Reuters, raising the
spectre of a painful new squeeze in a vital market for
Sources at euro zone central banks said political, legal and
technical hurdles were still standing in the way of industry
calls for them to lend out more of the 1.4 trillion euros ($1.48
trillion) of sovereign debt they have bought to boost inflation.
ECB policymakers opened the door to changes at their January
meeting after a bond shortage late last year saw investors pay
record rates to borrow government paper, for example to post as
collateral at the clearing houses which settle their trades.
Failure to come up with collateral when asked can lead to a
firm being put into default, with potentially destabilising
consequences for the financial system as a whole.
Huge debt purchases by the ECB and stricter European Union
rules for investment banks in the wake of the financial crisis
have siphoned off large amounts of highly rated sovereign debt
such as Germany's, the most prized form of collateral.
After the New Year squeeze, investors fear another, smaller,
drought at the end of March, when banks close their books for
the first quarter of the year and are reluctant to lend.
But the chances of an announcement at Thursday's meeting,
when the ECB is expected to keep policy on hold despite a recent
rebound in euro zone inflation, are slim, the sources said.
The ECB declined to comment.
Imminent help from the European Commission, which is
responsible for financial regulation, is also unlikely.
A Brussels official told Reuters more time was needed before
deciding on any easing of the rules on repurchase agreements --
through which cash is swapped for collateral -- to give banks an
incentive to continue lending at quarter-ends.
The ECB's decision in December to accept up to 50 billion
euros worth of cash, not just bonds, as collateral for lending
out sovereign debt has meanwhile fallen short of the mark.
That threshold was not even reached during the New Year's
squeeze, indicating the channel was simply not working.
Even though it is sitting on 270 billion euros of public
sector debt, the Bundesbank had made loans against just 4.3
billion euros worth of collateral on Dec. 31. That is less than
the ECB's own bond lending on that day, even though the ECB owns
fewer than half as many bonds as the German central bank.
Industry body the International Capital Market Association
has called, among other proposals, for bond-lending to be
centralised at the ECB, taking it away from national central
It hopes that would expand the pool of dealers which can
borrow those bonds and pass them on to investors, given that the
ECB has agreements in place with all banks across the bloc.
But this raises a number of issues, the central bank sources
First, national central banks own 90 percent of the bonds
bought as part of the ECB's quantitative easing scheme.
This is a deliberate feature of the programme and is
designed to limit the sharing of risk between euro zone
countries, so resistance to changing it is high.
Second, the ECB delegates all its government bond lending to
a single dealer, Germany's Deutsche Bank, and this
could present a bottleneck if Frankfurt were to take the bulk of
the lending upon itself.
Third, with previous changes to the scheme falling short of
expectations, some on the ECB's rate-setting body argue the
problem should be tackled at its root by further reducing the
volume of purchases.
The ECB is already scheduled to cut its monthly bond buys by
25 percent to 60 billion euros from April and further reductions
appear unlikely before elections in the Netherlands, France and
Germany due later this year.
This means the ECB may eventually have few other choices
than relaxing its bond-lending facility if it is to keep the
purchases going until the end of the year as promised.
Other industry suggestions include setting a floor on the
rate charged for lending out bonds or raising the cap on the
"We find it more likely that the ECB raises the maximum
limit of 50 billion euros for cash collateral in the facility
than changes in pricing," analysts at Nordea said.
"More attractive pricing, however, would be what probably
affected repo market conditions more."
($1 = 0.9465 euros)
(Editing by Catherine Evans)