The spectre of EU inflation racing towards hyper-inflation was looming over Europe tonight as currency dealers, credit managers, commentators and even bankers agreed that the European Central Bank’s decision to buy 16.5 billion Euros of sovereign debt bonds was effectively a decision to engage in wholesale quantitative easing.

The communique confirmed:

‘As decided by the Governing Council on 10 May 2010, the ECB will conduct specific operations in order to re-absorb the liquidity injected through the Securities Markets Programme. In this regard, the ECB will carry out a quick tender on 18 May at 11.30 in order to collect one-week fixed-term deposits with settlement day on 19 May. A variable rate tender with a maximum bid rate of 1.00% will be applied and the ECB intends to absorb an amount of EUR 16.5 billion.’

Opinion leaders were quick to respond. JP Morgan’s David Mackie wrote:

‘It is clearly inappropriate for any central bank to provide ongoing monetary financing for a sovereign which is no longer able to fund itself in the capital markets due to concerns about its solvency. That is the road to inflation, or even hyper inflation, which is why direct monetary financing of fiscal deficits is explicitly forbidden in the Lisbon Treaty’.

Former Bank of England MPC member Willem Buiter asks:

‘Does this leave the ECB with enough capital to be able to engage in effective monetary policy, liquidity policy and credit-enhancing policy – including quantitative easing?

‘With assets of € 1,795 bn and capital and reserves of € 73 bn, the Eurosystem has 24,6 times leverage. A decline of just four percent in the value of its assets would wipe out its capital. That does not look like a terribly comfortable position, as the quality of much of the assets it has accepted as collateral from Euro Area banks is likely to be uncertain at best.

‘Unlike the US banks and the UK banks, Eurozone banks have barely made a start on recognising the toxic and bad assets they are exposed to, on balance sheet or off-balance sheet. We know of the dreadful state of most of the German Landesbanken, the fragility of the bailed-out Commerzbank, the opaque balance sheet of Deutsche Bank, the precarious state of the remaining large listed Benelux banks, the exposure of the Austrian banks to Central and Eastern Europe etc. etc. If any of these banks had good collateral, they would not give it to the Eurosystem. They would sit on it.’

The lock of toxic debt revelation in the Eurozone has been an obsessive concern of The Slog for some eight months now.

But the Bloomberg site tonight reported that:

‘The Euro’s rebound from a four-year low bolstered optimism that the shared European currency will weather the region’s debt crisis.’ Among Slog contacts, it’s hard to find anyone who shares that optimism.

An exception is Goldman Sachs’ Jim O’Neill – but he’s not one of my contacts. During the last week, Jim has written favourably about the $1trillion EU bailout. In the last 72 hours, he has described ‘panic opinions’ about the Eurozone crisis as ‘ridiculous’. Goldman Sachs moves in mysterious ways, and I hope to bring you more on this in the coming days. O’Neill has rockstar guru status when it comes to currencies, but here at Slogger’s Roost we’re finding it hard to follow his reasoning.

In the meantime, ensure you understand the agenda of those who write on such matters. Whichever way you cut it, the ECB and its Eurozone banking partners are in deep doo-doo.