European Central Bank President Mario Draghi said he expects banks to increase credit supply after its next three-year operation as confidence returns to financial markets, making the currency a “safer place.”

While banks used an initial offering of three-year loans “to repurchase their bonds coming due in the first quarter of this year,” banks will now be “more inclined to use this money ― which was our primary expectation really ― to expand credit into the real economy,” Draghi said after a meeting of G20 finance officials in Mexico City.

The Frankfurt-based central bank is flooding the market with cheap money to head off a credit crunch, encourage lending to companies and consumers and spur demand for unsecured bank debt. Financial institutions will seek 470 billion euros ($633 billion) in a second round of unlimited three-year funds on Wednesday, approaching the 489 billion euro take-up at the first such operation in December, according to the median estimate of 28 analysts surveyed by Bloomberg.

“There is a return of confidence of the overall financial markets in the euro,” Draghi said. “The general sense is that the euro is now a safer place than it was at the time of the Cannes summit” of G20 officials in November, he said.

Bloomberg’s Europe Banks and Financial Services Index has rallied 18 percent this year, yields on debt of European sovereigns and banks have tumbled and the market for senior unsecured debt has reopened. Draghi said there are currently no signs that providing “abundant liquidity” is creating risks for the economy.

The three-year tender “seems to have contributed to dramatically reduce the financial instability that was still pervasive until year-end,” Draghi said. “But I would be cautious on giving all the credit to this monetary policy measure because equal if not greater credit should be given to the reforms that have been undertaken in a variety of governments of critical countries.”

Spain’s government cut firing costs, changed wage- bargaining laws and decided that people on jobless benefits will have to offer community service in an overhaul of labor rules that went into effect immediately. Italian Prime Minister Mario Monti has embarked on an overhaul of the pension system and measures to boost growth and fight tax evasion.

The economy of the 17-nation euro region will shrink 0.3 percent in 2012, with Italy and Spain facing sudden crunches as they battle to escape the debt crisis, the European Commission said last week, abandoning a November forecast of 0.5 percent growth. At the same time, a better-than-predicted performance in Germany and France helped mitigate a contraction in the fourth quarter, the region’s first since 2009.


‘Tentative Stabilization’

“We can see a tentative stabilization at low levels of activity but also with some signs, the very first signs of some improvements here and there,” Draghi said. “That’s for the average of the euro area. In some countries there will be a mild or more-than-mild recession, but for the average of the euro area the situation seems to be stabilizing.”

European Union Economic and Monetary Affairs Commissioner Olli Rehn said he expects the economies of the euro region and the EU-27 to return to growth “in the second half” of 2012. 

(Bloomberg)