As the European Central Bank prepares to meet for the first time since last week's move to ease the funding strains on Europe's troubled banks, Wall Street is speculating about whether it may do even more.
The world's central banks banded together last week to lower the cost for European lenders to acquire dollars. But analysts said that, while borrowing for banks is now cheaper, it isn't any easier.
The ECB left intact a demand that banks pledge high-quality bonds as collateral. Among the criteria, the collateral should be bonds rated single-A-plus or higher and backed by consumer, residential and other loans. The ECB also demands bonds issued in the euro zone and denominated in euros.Trouble is, the value of those bonds has slumped amid the ballooning sovereign-debt crisis. That forces banks to increase the amount of securities they pledge to the central bank to obtain dollar loans.
The dollar-lending facilities as they now stand "won't make much of a difference," said Geoffrey Yu, director of foreign-exchange strategy at UBS AG. Some analysts said they expect changes in the collateral required by the ECB following the central bank's meeting Thursday.
"The probability is high for an ease in the criteria," said Adrian Miller, senior vice president for global-markets strategy at Miller Tabak Roberts Securities LLC in New York. The ECB has recently shown a determination to ease the financing strains, he said, and this would go a long way toward helping.
The ECB could accept lower-rated debt, as well as bonds issued in other currencies, including the dollar and yen, analysts said. The ECB declined to comment.
The ECB is next scheduled to auction dollars on Wednesday. That auction will be the first test of whether a lower rate, without an easing of collateral standards, will be enough to attract banks that are paying significantly more to get dollars in the open market.
European banks need dollars to fund their non-euro activities. Typically, they swap their euros for dollars with another bank, without having to pledge any collateral. The cost of the transaction is expressed in the gap between interest paid and either the euro or London interbank offered rate, a benchmark lending rate.
The cost of swapping euros into dollars is measured using the so-called three-month euro-dollar cross-currency basis swap. This indicator was at minus-1.55 percentage points before the central banks' announcement. On Tuesday, it was at minus-1.16 percentage points, according to ICAP via CQG.
The move by central banks last week brought down the ECB's rate to about 0.58 percentage point, well below the market rate.
Funding costs are a key indicator of the health of the financial system: Higher costs point to banks' own financing difficulties. Policy makers around the world have sought to avoid having problems in the banking system—stemming from the euro-zone debt crisis—spill over into a full-blown credit crunch.
Mr. Yu said he expects the ECB to lend out more dollars than it had before cutting lending costs, but not enough to end Europe's dollar-funding problems. The ECB has pulled about $2 billion this year from the Fed at banks' request. In 2008, the last time dollar-funding costs were this high, that figure peaked at $286 billion, according to Bank of America Merrill Lynch.
Bank of America analysts said as little as $10 billion is likely to be tapped at Wednesday's auction. The latest auction comes as a key source of funding for European banks has dried up. Funding from U.S. money-market funds has dropped $220 billion since May, according to Barclays Capital.
One factor that could keep banks away from the auction is reputational risk, analysts said. Banks can use the ECB's dollar-funding line anonymously, but they fear that, if word gets out, other banks might not want to lend to them..