Huge ECB cash injection dwarfs BoE auction

The scale of the ECB injection dwarfs the emergency funding that stunned financial markets at the start of the credit crunch in August. Unlimited sums of money are being provided for two weeks at 4.21pc, some 70 basis points below the three-month Euribor rates that set mortgages in Spain, Ireland and elsewhere.

"This is a huge sum: the banking system is now awash with short-term funds," said Julian Callow, eurozone economist at Barclays Capital.

It is an admission that the central banks of Europe, Britain, and North America failed to unfreeze the credit markets with a collective promise of $90bn in funding and a blizzard of reassuring words last week.

Spreads on three-month Libor rates remained stuck at 69 basis points in the US, 93 in Britain, and 95 in the eurozone (Euribor) after their grandiose gesture, while the US commercial paper market continued to shrink for the 18th week in a row as lenders refused to roll over loans. It has shed $400bn since August. The various indexes measuring appetite for mortgage and corporate debt are still flashing storm warnings.

"Offering unlimited liquidity is an emergency move," said Hans Redeker, currency chief at BNP Paribas. "The central banks have been behind the curve and now realize that the problems are deeply rooted," he said.

What is not known is whether British banks used their subsidiaries in the eurozone to tap the ECB's spigot at far lower rates, and on easier terms. The ECB allows them to borrow against bonds with a credit rating as low A+ and a wide array of mortgage securities - so long as they are in euros.

"The ECB is a very broad church," said Marc Ostwald, an economist at Insinger de Beaufort. "Banks can hand over almost anything they want as collateral and borrow cheap, so it is likely that British banks are going there for funds."

The Bank of England has relaxed its collateral standards a little to help nurse lenders through the credit crunch. It accepted top-grade residential mortgage securities yesterday, as well as AAA covered bonds, and G10 agency bonds, but the range is much more restrictive.

The modest level of bidding at the Bank of England auction could mean that most UK banks are in decent shape, with the exception of one lender that bid at rates as high as 6.6pc, 22 basis points above market Libor. But it could also mean that they are playing "central bank arbitrage", shopping for liquidity. If so, this pattern of behaviour could greatly weaken the ability of any future British government to resist demands from Brussels for an EU-wide super-regulator (already on the agenda) and have major implications for the City of London.

An EU source said reports that the British banks were feasting at the ECB window were "overblown".

In theory, yesterday's liquidity blitz was a short-term house-keeping measure to keep the markets fluid through Christmas and New Year. The markets remain sceptical, suspecting that the eurozone may be harbouring something very nasty - possibly in the Spanish banking system.

The ECB cannot allow the risk of a "Northern Rock" in Europe because there is no European government to take charge. Any suggestion that German taxpayers might have to bail out a Club Med bank would be politically explosive, testing the viability of monetary union. This is why Frankfurt has been most willing to open the floodgates at each stage of the crisis.

Nouriel Roubini, a professor at New York University, said the ECB and fellow banks were now engaging in "stealth" rate cuts. "Liquidity palliatives and band-aid will not work. This severe liquidity crunch is due to insolvency and widespread lack of trust. The failure of central banks to provide the appropriate diagnosis of the crisis and now their failure to provide enough monetary policy easing to reduce the damage on the real economies is worrisome," he said.

The ECB is constrained by inflation, now running at 3.1pc - the highest since the launch of the euro. Even so, the mood is shifting. Jurgen Stark, the ECB's chief economist and arch-hawk, told Italy's Il Sole yesterday that Europe would not be able to shake off the US slowdown. "I don't believe in the decoupling hypothesis. People who talk about it stress the trade links between the US and the eurozone, but you have to remember that the financial links and the effects of confidence are more important. We will not be immune," he said.