FRANKFURT - The European Central Bank siphoned off a record amount of overnight cash from overstuffed money markets on Tuesday, although banks continued to soak up the money it is simultaneously shovelling in over the longer term.

The ECB is eager for banks to increase lending to firms and consumers, hoping this will boost investment by firms and consumption by households, and reinvigorate the recession-hit euro-zone economy.

In a bid to speed the process, the ECB flooded the banking system with a record 442 billion euros of ultra cheap funds late last month. The loans last for a year, an unprecedented duration.

But in order to clear the overhang of excess cash, the ECB was forced to drain a record 276 billion euros ($385.8 billion) from overnight money markets to remedy the situation over the end of its monthly maintenance period.

The tactic is regularly employed at this point in the liquidity cycle as the ECB tries to ensure there is not too little, or too much, cash in the system. ECB27

However, as it was taking money out of one part of the system, it was coming back in elsewhere. Banks took 106.4 billion euros in the ECB's regular weekly refinancing operation and just over 38 billion in one-month loans.

The ECB will not be too disheartened though. While demand in the weekly tender was a fraction above last week's equivalent, banks took 16.5 billion less this time around in the one-month tender, so the amount of excess funding should decline.

Liquidity supply should become clearer on Wednesday, when the ECB will allot a fresh set of three and six month loans. Last time banks took a combined total of 20.5 billion, however at that point many were anticipating further rate interest cuts from the ECB. This time they are not, and analysts expect demand to ease.

WHERE'S THE EXIT?

The move to flood money markets is designed to give banks the necessary incentive to lend more freely to firms and consumers again and at a cheaper rates.

ECB Governing Council member Axel Weber toned down his recent suggestions that the central bank could begin circumventing the banking system and start buying corporate bonds if banks did not increase their lending to firms and consumers.

Weber said the Bundesbank saw no need to buy corporate bonds at the moment and this was a step central banks would only undertake if they concluded the banking channel had become dysfunctional. [ID:nWEA0015]

While it still too early to expect banks to have found something constructive to do with the ultra-cheap 12-month funding, the signs have not been encouraging.

Banks parked a record 315 billion euros of the funds back at the ECB, data showed this week, and analysts are still uncertain whether the massive injections will have the desired impact.

It's not obvious to me that this (banks not lending) is a problem that is going to go away quickly, said James Nixon, an economist at Societe Generale.

I rather think that this lack of financing for some of the banks is going to be a long-term problem and I wonder whether the ECB isn't going to find itself having to maintain this kind of liquidity provision, Nixon said.

I really wonder whether they can go back to a situation where they tell the banks they have to fund themselves from the market place, and as soon as you do that, if that funding is not available, they are going to have all sorts of problems.

I think we could find ourselves with the ECB maintaining that kind of level of support for many, many years, he added.

The system could already be receiving another shot of liquidity. The ECB kicked off an unorthodox plan to buy 60 billion euros worth of covered bonds on Monday although it is yet to reveal any purchases.

For details of previous ECB overnight lending operations please go to the ECB web site: here (Reporting by Marc Jones; Editing by Victoria Main)

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