Demand for the European Central Bank's first ever offer of three-year loans to banks on Wednesday is likely to go a long way to determining whether countries embroiled in the debt crisis receive some relief or have to endure yet more pain.
The ECB hopes the limit-free, ultra-cheap and ultra-long funding will have a range of beneficial effects, including bolstering trust in banks, easing the threat of a credit crunch and most of all, tempting banks to buy Italian and Spanish debt.
Analysts say that take-up above 350 billion euros is likely to be taken as a positive sign for strained countries and a potential catalyst for some thawing of the frozen money market.
In contrast, a figure near the 57 billion euros banks took when the ECB relaunched one-year loans back in October would be a blow and viewed by many as a vote of no-confidence in Italy and Spain.
Traders polled by Reuters predicted 250 billion euros being taken on Wednesday, the same demand the ECB gets for one-week loans and nowhere near what is needed to see Italy and Spain through next year. But the range of forecasts, from 50-450 billion, shows just how much uncertainty there is.
In normal circumstances the ECB would expect to be inundated with demand. In 2009, when it handed out its first ever one-year loans banks borrowed a massive 447 billion euros, but interest this time around is being dampened by the deepening debt crisis.
"There is a lot of optimism at the moment that banks will take the ECB money and buy high yielding euro zone periphery debt in a nice carry trade which makes them some profit and which they can then invest in their own balance sheets," said Azad Zangana, an economist at Schroders in London.
"I'm not sure it is quite going to happen quite like that though," he added, like many economists questioning the appetite for those kind of bonds in the current environment.
A number of banks got their fingers badly burnt in 2009 when they invested their ECB money in Greek and Portuguese bonds and the new offerings come as investors demand banks reduce their exposure to the euro zone rather than increase it further.
Spanish short-term financing costs fell sharply from a month earlier at auction on Tuesday, with analysts saying banks were planning to tap the 3-year liquidity to pay for the relatively high-yielding paper.
But buying short-term bills is one thing, investing in longer-term bonds quite another.
Given those doubts, most market experts say only more aggressive and direct buying of government bonds by the ECB will help ease the crisis, something it is reluctant to do.
The consensus view of a meeting of top money market traders and ECB officials held in Frankfurt last week was that a large take up could help some banks dispel fears about their immediate health and ease them back into the wholesale market.
"We will have to wait to see what the demand is. If it is high then it will be good for money markets, if it isn't it won't make any difference," said one of the traders at the meeting who requested anonymity.
ECB President Mario Draghi has been pressing banks to take the money since announcing the plans earlier this month.
For some banks the money could be more than 3 percentage points cheaper than they can get on the open market. As part of the deal they can switch money borrowed from the ECB back in October into three-year funding and will also be able to pay it back after just a year if they so wish.
Contrary to mixed trader expections, a number of economists see demand topping 450 billion euros, although many feel it will be used to boost banks' own funding rather than to buy euro zone bonds as French President Nicolas Sarkozy has urged.
"This so-called Sarkozy trade where banks use the money they borrow from the ECB to buy sovereign bonds is wishful thinking quite frankly," said Tobias Blattner, a former ECB economist now at Daiwa Securities.
"Banks in Italy and Spain will always buy the debt of their sovereigns but banks in German and France certainly won't. They do not want to push away their investors and their investors are telling them to reduce exposure to periphery euro zone debt."
The view echoes comments from UniCredit chief executive Federico Ghizzoni, who last week told reporters that using ECB money to buy government debt "wouldn't be logical". His bank is traditionally one of the biggest buyers of Italian government bonds, with almost 50 billion on its books.
Those who see high demand point out that banks are now more reliant on the ECB for funding than they have ever been.
French banks have almost quadrupled their intake of ECB money since June to 150 billion euros, while banks in Italy and Spain are each taking more than 100 billion euros. At the same time, almost two-thirds of money borrowed from the ECB is being deposited straight back there, compared to one-third after the collapse of Lehman Brothers in late 2008.
However, others argue demand could be crimped as some banks remain short of ECB eligible collateral even after its latest relaxation of borrowing rules, a problem Draghi has stressed.
One top executive at a major European bank told Reuters that despite Draghi's argument to the contrary this week, using ECB funding is still viewed as a sign of weakness and that banks will try to avoid using it.
They will also be questioning what happens when the three-year loans have to be paid back.
"The (ECB's) unlimited liquidity may not be there in three years so that is that the other issue," said Zangana from Schroders. "Will they have to just sell the bond again in three years time because if everyone is doing that it would create the same problem all over again."
© 2022 Thomson/Reuters. All rights reserved.