Trichet privately fears collapse as ECB under intolerable pressure

Strains in the eurozone short-term lending markets have jumped sharply this week as banks hoard cash and refuse to lend to each otheramid worries loans will not be repaid in a deteriorating financial climate.
Strategists say the eurozone’s financial system would be close to breakdown without emergency loans from the European Central Bank, which they warn cannot last forever.

Nick Matthews, senior European economist at RBS, said: “We are at a key moment in the eurozone debt crisis. There are tensions in the financial system with still many banks having difficulties accessing the private markets for loans. These banks have to rely on the ECB as a backstop. But this is not a long-term sustainable solution.”

Don Smith, economist at Icap, the broker, said: “We have seen a step-change in worries about the banking system because of the sovereign crisis in recent weeks and days. Banks are refusing to lend to each other because of worries over counterparty risk.”

Money being dumped at the ECB has shot through the roof.  The amount of money banks are depositing at the ECB rose to €169bn on Tuesday, the highest level since August 2010. It remained at elevated levels of €166bn on Wednesday. That compares with €4.98bn on June 15.

Italy’s banks are struggling to access the markets, and thus been forced to borrow more from the ECB. The amount of money Italian banks borrowed from the ECB jumped to €85bn in August, twice the amount of June, which stood at €41bn.

The total amount of loans the ECB has lent to eurozone banks stands at €438bn, with the peripheral nations of Greece, Ireland and Portugal, which have been shut out of the private markets since the start of the year, heavily reliant on central bank funds. Greek banks, for example, have €103bn in outstanding loans from the ECB, double the amount they borrowed at the end of 2010.

There is a grave danger that, as fast as money is parked at Trichet’s central bank, it goes straight out of the back door to prop up Greece and Italy. The ECB itself must be considered at risk in this context.

All this was ‘unthinkable’…but also inevitable. Now it is here. The weekend intervenes yet again offering a breathing space: but the eurozone is terminally ill. It is on a drip-feed from the central bank in Frankfurt, and that cannot be sustained.

Hello in Downing Street? Anyone home?