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Euro zone loans slump, ECB waits for new measures to kick in

FRANKFURT (Reuters) - Lending to households and firms in the euro zone contracted more sharply in May than a month earlier, highlighting the economic weakness in the bloc that the ECB sought to address with a bundle of measures earlier this month.

Over time, the ECB has cut interest rates to record lows, pumped extra liquidity into the banking system and widened the pool of assets it accepts in return for funding, but the measures have so far not managed to unclog lending to the real economy.

The central bank is now putting the bloc's top banks through a thorough review of their balance sheets to weed out soured loans, update collateral valuations and adjust capital so that they can lend more freely in future.

However, loans to the private sector fell by 2.0 percent in May from the same month a year earlier, ECB data released on Monday showed, after a contraction of 1.8 percent in April.

Earlier this month, the ECB introduced a series of new measures to encourage lending, including a cut in its deposit rate to below zero to discourage banks from holding money at the central bank. The May lending data would not have been influence by theses steps.

Euro zone M3 money supply - a more general measure of cash in the economy - grew at an annual pace of 1.0 percent in May, up from 0.7 percent in April.Howard Archer, economist at IHS Global Insight, said the weak data would probably expectations that the ECB will ultimately have to take further policy action, but that the figures would have little near-term impact.

"The ECB is clearly going to sit tight for now at least while the interest rates and liquidity measures it announced at its June meeting increasingly kick in," Archer said in a research note.

The bank has said it will probably not know until the end of the year whether the new measures have been effective, but that more action would come it necessary. The Governing Council meets again on Thursday.

Executive Board Member Yves Mersch said in an interview broadcast on Sunday that the bank sees no acute risk of deflation, but it does see a long period of low inflation ahead.

Asked about widespread expectations that interest rates will stay low until 2016, Mersch said: "If everything else stays as it is today then that could be the model."

(Reporting by Eva Taylor and Paul Carrel; Editing by Jeremy Gaunt)

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