By Krista Hughes FRANKFURT, Oct 9 (Reuters) - Changes to the fine print of the European Central Bank's liquidity operations may achieve more in guiding markets through the financial crisis than the headline-grabbing cut to its benchmark interest rate. The ECB joined other major central banks on Wednesday in lowering its main refinancing rate by half a percentage point to 3.75 percent, the first cut in more than five years and its biggest move since mid-2003. A few hours later ECB policymakers decided to suspend the auction system of providing euro zone commercial banks with weekly supplies of liquidity, which are more important than ever due to banks' extreme reluctance to lend money to each other. Until now the ECB offered funds to the highest bidders, a practice which had pushed average rates paid as high as 4.99 percent -- almost three quarters of a percentage point above the previous official rate. Now the ECB is offering unlimited funds at a flat rate of 3.75 percent. In addition, the ECB halved the premium charged on overnight emergency loans and set the interest rate it pays on deposits proportionately higher, encouraging banks to increase their already heavy use of the ECB's overnight facilities. These measures narrowed the corridor between the emergency lending and borrowing rates to 100 basis points from 200 before. Analysts said the liquidity moves would provide immediate relief to banks struggling to raise cash, giving them access to more money at a lower cost. "They're opening the floodgates for liquidity," said David Schnautz, interest rate strategist at Commerzbank in Frankfurt. The measures will also help bypass the lack of trust which is preventing banks from lending to each other, and infecting their customers. ECB figures show banknotes in circulation jumped by a massive 11.5 billion euros last week, coinciding with well-publicised emergency rescues for several banks. "There is still an enormous lack of trust among banks," one euro zone stock trader said. "They don't even telephone each other any more." Economists said the combined impact of the ECB moves was an effective rate cut of close to 1-1/4 percentage points, given the high rates bid at ECB tenders in the past two weeks. "Although less spectacular than the co-ordinated rate cuts yesterday, the reform of the ECB auction procedure as well as the narrowing of the 'policy rates corridor' announced later in the day could prove key to a gradual improvement in money market conditions," RBS economist Gilles Moec said. "It is probably too late to avoid some recession in the euro zone until well into 2009, but it is not too late to avoid a catastrophic fall in bank credit supply which would turn the possibly mild recession into a more prolonged and far-reaching crisis." SYMBOLIC, BUT SLOW In an interview with Reuters, ECB President Jean-Claude Trichet said the coordinated rate cuts aimed to boost confidence generally, while the liquidity measures should reassure banks that they could rely on the ECB to keep liquidity circulating even if bank-to-bank lending remains frozen. (For details please double click on [ID:nL9181361]) Economists said one of the main differences between the two measures was the speed with which they would take effect. The ECB rushed to implement its new flat-rate refinancing regime on Thursday with a six-day tender at the new 3.75 percent rate. But market turmoil could delay the already dragged-out impact of official rate changes on the euro zone's economy. "The fixed-rate tenders and the narrowing of the rate corridor will have immediate impact within days whereas the rate cuts, the coordinated rate cuts, were not designed to try to support equity markets yesterday," Deutsche Bank economist Mark Wall said. "The objective there is to reduce policy rates to protect economies from the downdraft through the next 12-24 months. This is a confidence move." Conventional wisdom holds that the euro zone responds more slowly to changes in official interest rates than countries such as the United States. This is due to factors including more regulated labour markets, fewer homeowners with fewer variable-rate mortgages and the fact that banks pass on rate changes to their customers more slowly. This means the euro zone economy can take up to two years to digest rate changes fully. Clogged money markets are not only holding up the supply of funds around the global financial system, but they could also delay further the impact of monetary policy decisions on the economy. ECB Executive Board member Jose Manuel Gonzalez-Paramo said on Sept. 25 that the ECB was considering the impact of impaired functioning of money markets on the pass-through of rate changes, although it was too early to draw conclusions. Slower transmission of monetary policy decisions might mean that the ECB has to cut rates more and faster than it has in the past to have a similar effect on the economy, economists said. Barclays Capital economist Julian Callow said the relative unresponsiveness of the economy meant the ECB could not afford to make Wednesday's move a one-off. "The extreme elevation of inter-bank spreads signals that the usual monetary transmission mechanism out to bank lending rates is not functioning correctly, which would imply that the ECB needs to engage in substantial easing, first to help the financial sector, as a precursor to seeing much impact in the real economy," he said. In the last rate cut cycle, the ECB took just over two years to cut benchmark rates from 4.75 percent to the historic low of 2.0 percent -- an average move of 10 basis points per month. Economists polled by Reuters predict the ECB will chop another half a percentage point from rates before the end of the year, which would mean 100 basis points of easing in just three months. [ECB/INT] (Additional reporting by Hakan Ersen in Frankfurt and London markets team; editing by David Stamp)

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