As the ECB introduces cheap capital for 3 years via its LTRO, its nothing more than a trick to fund sovereign debt by the back door. While it is currently restrained in its capacity to just simply print money and under pressure by the Germans to not do so this method enables Draghi to indirectly fund eurozone foreign debt.

The proof of this is Spanish yields last month on its three month notes had hit 5.11%, but on Tuesday went as low as 1.74%. Banks will be able to borrow cheap at 1% and buy Italian, Spainish bonds at 5 and 6%.  

Mark Schofield of Citigroup had this to say about it.

“This may help sovereign debt a bit bu t we don’t think it is a game-changer,” said Mark Schofield, rates chief at Citigroup, predicting that banks will use the money to plug other holes and cover a dollar funding squeeze. “Most banks already hold too much of their own government’s debt. It may take coercion to make them buy more.”

UBS took a look at the figures and concluded that bank will still be under capitalised.

Obviously the relative take-up of the ‘bailout’ will decide just how much ‘free-money’ the banks can potentially reap (were they ‘ultimately’ all-in enough to do the carry trade) before the EBA’s capitalization deadlines, but it is clear that even in an extremely large take-up scenario (and extended deadline) – the earnings will not come close to covering bank (capitalization) needs. The Japanese rear-view mirror perspective on this is hardly supportive as the Europeans follow the same ‘short-term-solutions-and-zombification-via-capital-needs-extensions’ strategy which will inevitable require the investment (read bailout) of public funds (as it did in Japan in both 1998 and again in 2003).

Predicatably Sarkozy has only one intention for the LTRO 

French President Nicolas Sarkozy has suggested banks could use the loans to buy even more government debt.

Simon Derrick, chief currency strategist at Bank of New York Mellon Corp, said the loans amount to quantitative easing “through the backdoor.”

“What the ECB is doing is providing ultra-cheap money to banks, which in turn are going to be in there buying the sovereign debt up,” Derrick told Linzie Janis on Bloomberg Television’s “First Look” earlier today. “That’s good news in the sense that it’s clearly going to help sovereigns in the near future, but it’s also printing more money. That’s going to start to weigh on the euro over time.”

And where does Draghi and ECB get this money for funding the LTRO, why its made out of fresh air. Buckle up for inflation.

Sources: TelegraphZeroHedge, Bloomberg