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ECB chief: Emergency loans not fueling inflation

David Mchugh, AP Business Writer

Mario Draghi, President of the European Central Bank, delivers his speech on the annual reception of German private banks in Berlin, Monday, March 26, 2012. (AP Photo/Markus Schreiber)

FRANKFURT, Germany (AP) -- European Central Bank chief Mario Draghi said he sees no inflation threat from the bank's infusion of than €1 trillion ($1.3 trillion) in emergency loans, a bold move that has stabilized the continent's banking system.

Draghi addressed head-on some of the worries about the bank's large credit injection during a speech Monday in Berlin. He declared that any excess money in the financial system can be quickly sopped up by the central bank when the time is right and that the bank is managing the risks of taking on lower-quality collateral in return for the loans.

The central bank head argued that recent economic indicators suggest the ECB loans haven't led to an excess of credit or an increase in the money supply in the 17-nation eurozone.

The two massive rounds of loans — €489 billion ($649 billion) to 523 banks on Dec. 21 and €530 billion ($704 billion) to 800 banks on Feb. 29 — have eased Europe's debt crisis by steadying banks and making it easier for governments to borrow. The loans were effective because they are for up to three years — compared to the previous longest offering of one year — and currently cost only a 1 percent interest rate.

Despite the move's success, there have been some worries about the risks since the ECB loosened its collateral requirements to enable more banks to take the loans.

Germany's central bank has cited the risks of taking weaker collateral and the chance that such massive support would prop up unsustainable banks and lower government resolve to tackle deficits and improve growth.

Draghi said it was key for governments to use the respite to act now.

"The present situation provides a window of opportunity for governments to accelerate efforts to consolidate budgets, to boost employment and to enhance competitiveness — and to do so with confidence," he said.

He said the added ready money would only boost inflation when and if lending takes off.

"We would expect an impact on inflation and asset prices only following a sustained and strong increase in money and credit, not following an increase in central bank liquidity per se," he said. "The tentative signs we are seeing of a stabilization in money and credit growth do not signal increasing inflationary pressures over the medium term."

Instead, lending by banks to the private sector has only stabilized, growing by a below-average 1.5 percent in January. The broadest measure of the supply of money in the eurozone economy, or M3, grew only 2.5 percent that month, well below the 5.9 percent average over the 13-year life of the shared euro currency.

M3 is an arcane statistic for most people but the bank follows it closely, since excessive monetary growth can be inflationary. Controlling inflation is the ECB's main job under the basic European Union treaty.

Inflation in the eurozone ran at 2.7 percent in February, higher than the bank's goal of just under 2 percent, and is expected to remain over 2 percent for all of this year before falling. The bank mostly blames higher oil prices and some tax increases for that, not monetary factors.

The amount of new credit the ECB loaned was actually about €500 billion ($664 billion) since banks moved some money from other ECB credit offerings to the two so-called longer term refinancing operations.

Draghi said the risk to the ECB from accepting lower-quality collateral was being managed by requiring more collateral than the amount of the loans in some cases. For newly eligible collateral such as loans to companies, the ECB was demanding on average €100 of collateral for every €47 in credit to banks. That insures the ECB against losses if the banks don't pay the loans back.

The ECB is also letting banks park a wider range of financial assets at the central bank in return for the loans so more banks could tap the cheap credit, especially smaller banks that supply the financing that small businesses need to operate. Smaller businesses are key because they employ most of the eurozone's workers.

When the economy picks up, the bank can quickly drain the added liquidity from the system by increasing the required reserves that banks must keep at the central bank or by taking either short-term or long-term deposits from banks, he said.

Some banks have used the money to pay off financing debts that were coming due while others used some of it to buy government bonds, easing borrowing for heavily indebted governments such as Spain and Italy. That eased fears they might have trouble paying their debts due to high borrowing costs — the factor that pushed Greece, Ireland and Portugal to need bailout loans from the other eurozone countries.

But some of the money has been kept back by banks that are under pressure from the European Union to strengthen their finances against the debt crisis. Extra cash has also been washing back to the ECB as overnight deposits, although Draghi stressed it was not coming from the banks that had borrowed the funds but from others.