The Financial Times is reporting ECB emergency fund tapped for €3.9bn.

The European Central Bank’s emergency lending fund, which attracts a penal interest rate, was tapped on Wednesday for €3.9bn – the largest sum since October 2004, the Frankfurt-institution has revealed.

The surge in demand for the ECB’s “marginal lending facility” pointed to the difficulties still being faced by European banks as a result of the global credit squeeze. The ECB revealed no details but it is likely that more than one borrower was involved. Use of the marginal lending facility attracts a 5 per cent interest rate – significantly higher than market rates.

The ECB took the initiative among central banks in addressing the credit squeeze on August 9, when it pumped an unprecedented €94.8bn into money markets. But it has kept a clear distinction between such liquidity-boosting operations and its main interest rate policy, aimed at combating inflation over the longer term.

German inflation data, meanwhile, suggested that eurozone prices could soon be rising at a rate in excess of the ECB’s target – an annual inflation rate “below but close” to 2 per cent.

Growth in the broad money supply measure, M3, which the ECB sees as sending early inflation warning signals, remained high at 11.6 per cent in August, only slightly lower than July’s record of 11.7 per cent.

German inflation data, meanwhile, suggested that eurozone prices could soon be rising at a rate in excess of the ECB’s target – an annual inflation rate “below but close” to 2 per cent.

“Once the money market distortions fade, very strong M3 growth in combination with the increase in price risks….will probably bring inflation concerns back into the ECB’s focus,” said Marco Kramer, economist at Unicredit in Munich.

Since December 2005, the ECB has lifted its main interest rate eight times to 4 per cent. It had planned another rise, to 4.25 per cent, this month but shelved the move because of the uncertainty about the macroeconomic outlook resulting from the credit squeeze.

The ECB which does does focus on credit expansion as reflected by M3 (unlike the US which discarded the measure) is boxed in by a credit crunch that originated in the US.

Why Europe Matters More

Minyan Peter, popular on the “The Ville” has this take on Why Europe Matters More back on September 7th.

While I know everyone’s attention is on the U.S. equity market this morning, I wanted to revisit why I put so much emphasis on the European credit markets. Let me summarize why.

First, as the rest of the market is quickly discovering, the European banks have been the major liquidity providers to the asset-backed commercial paper market. Those banks’ ability to meet their liquidity obligations to refund maturing paper is a clear sign as to whether this cycle can wind down in an orderly fashion, or whether there will be a panic. But to be clear, we are in wind down mode, and one that will take years.

Second, there has been a significant debate among financial pundits around the ability of the rest of the world to “decouple” from the U.S. consumer debt issues. (That is to say, the rest of the world will continue to motor along just fine, even though the U.S. is in an economic slowdown.) Economic prosperity requires a strong financial services sector. You can’t grow an economy if banks are unwilling (or unable) to lend money.

If the European banks become preoccupied with the fall out from their U.S. credit exposures, it will more than likely reduce their ability to lend into their domestic markets. (And we are already seeing concern about this being voiced by the ECB.) Without liquidity, their domestic market growth will slow down. …

Third, the Spanish housing market is already in a significant decline and you are beginning to see commentary regarding a possible (and I believe real) U.K. housing bubble. …

Finally, without economic strength in the United States and, I believe increasingly likely in Europe, the looming question becomes Asia. …

Minyan Peter

Minyan Peter offered these thoughts today:

What I don’t believe US investors appreciate is how much of our credit is in the hands of European financial institutions – either on balance sheet or through special-purpose vehicles. And as the consumer continues to deteriorate it can’t help but impact Europe first. As I said to someone the other day, watching the European markets is like watching the coming attractions of a movie.

It also feels to me like we are beginning to see a breakdown between the commodity markets and the dollar/Euro exchange rate. Many participants believe that these two markets will continue to move in tandem – the dollar will fall and commodity prices will rise.

But exchange rates reflect relative economic strength. Should we see more trouble in the European bank market – and remember, we’ve already taken down two German banks and a British bank – I believe that all bets are off on the dollar/Euro exchange rate. At least in the short run.

I don’t know that the market is positioned at all for that. And how that plays out through the commodity/China trade will be interesting to see.

Minyan Peter (Position in FXI.)

Beneath the surface a global credit crunch is still simmering even if the stock markets suggest otherwise. Thanks Peter and thanks Minyanville for that focus on Europe for our European friends.

Mike Shedlock / Mish/