Euro central banks can lend out more bonds to aid repo market, ECB's Constancio says

FRANKFURT (Reuters) - Euro zone central banks can lend out more of the bonds they have bought as part of the European Central Bank's stimulus program to support the market for short-term funding, European Central Bank Vice President Vitor Constancio told Reuters on Thursday.

The ECB's purchases of more than a trillion euros ($1.06 trillion) of euro zone government bonds have made it hard for investment funds to source such high-quality collateral to use for borrowing in so called repurchase-agreements, or repos.

Constancio's comments confirm that the ECB is keen to avoid the freezing of the 5.5 trillion euros repo market, as exclusively reported by Reuters on Wednesday. The repo market is key for transmitting ECB stimulus to the economy and is used by investment funds to finance trading.

"All national central banks ... should also offer securities lending to help the liquidity in the repo markets and so we hope and we provide our guidance (for that)," Constancio said.

"I think all of them can do a bit more in the securities lending activity that then supports the repo market."

A freeze in repo lending risks undoing some of the ECB's stimulus by hampering lending between financial companies and leaving bond markets vulnerable to sharp selloffs.

Sources have told Reuters the ECB is looking for ways to lend out more of its bonds and the issue would be discussed at the ECB's Dec. 8 meeting, when rate setters will also decide on whether to continue purchases beyond March.

Possible changes include reducing charges for firms which fail to return on time the bonds they have borrowed, accepting new types of collateral and extending the duration of loans.

Any decision on bond lending might not be finalised in December and will depend on what other changes the ECB makes to its asset-purchase program.

ITALIAN REFERENDUM

Constancio had said earlier the ECB would watch out for any fallout from Italy's Dec. 4 referendum, on which reform-friendly Prime Minister Matteo Renzi has staked his political career.

Investors fear that Italy could be plunged into political uncertainty if Renzi fails to get his constitutional reforms through and resigns.

"It’s the sort of political uncertainty that will trigger or not an economic shock in financial markets," Constancio said. "And depending on the degree of that shock, then we have to see if we have anything to do or not."

In the Reuters interview, Constancio said he did not think financial markets were pricing in the risk of a break-up in the euro zone.

"I don’t see that (break-up) risk still reflected in market prices," Constancio added.

"(Bond yields) have gone up everywhere, a little bit more in Italy as a result of concerns about the result of the referendum but to levels that are still very low."

(Editing by Jeremy Gaunt and Andrew Heavens)