Money markets low interbank rates could survive ecb cash letdown

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Feb 14 Some government bond investors may be disappointed if the amount of cash banks borrow from the ECB this month does not live up to rising expectations but money market rates are likely to weather any below forecast take up. A Reuters poll showed the European Central Bank was expected to pump half a trillion euros of cheap three-year loans into the euro banking system on Feb. 29, up from 400 billion euros in a poll last week and 263 billion euros in a mid-January survey. At the first three-year auction in late December, banks grabbed 489 billion euros. A stressful end of the year for euro zone banks made many analysts reluctant to bet they will use the 1 percent rate loans to buy higher yielding sovereign debt. But a sharp drop in short-term Italian and Spanish debt yields since the start of the year is now increasing expectations for the second take-up. This is further fuelling the peripheral debt rally, raising questions as to whether expectations are spiralling out of control."If demand is far smaller than expected this could disrupt the recent trend of tighter spreads and steeper curves (in peripheral bond markets)," BNP Paribas rate strategist Patrick Jacq said who expects demand to be 350-450 billion euros. In money markets the impact would be more limited given that interbank lending rates have already been set on a clear falling trend by the unprecedented excess liquidity seen after the first tender, he added.

Spreads between overnight index swaps and benchmark interbank rates, widely used as a gauge of money market tensions, could re-widen temporarily, but that will only be a knee-jerk reaction, he said. Some analysts argue that low demand could also be interpreted as a sign that banks are confident they can refinance their debt, while a very large take-up could raise concerns about the dire state of the euro zone financial system."A 200 billion result will be more positive than a 1 trillion result. The market would view that as banks not requiring significant liquidity needs," said Padhraic Garvey, head of investment grade rate strategy at ING.

REPOSITIONING

Shifts in demand at the ECB's one-week and one-month tenders on Tuesday also supported expectations of a large take-up. Banks reduced their intake of one-month funds to 14 billion euros from 39 billion euros in a previous one, but increased their demand for one-week loans to 143 billion euros from 109 billion."There could be an element of repositioning from a longer to a shorter dated refinancing operation in order to take part in the three-year (tender) in a couple of weeks time," Credit Agricole interest rate strategist Orlando Green said. Euribor futures stabilised after last week's sell-off following a post ECB meeting paring back of expectations for more ECB interest rate cuts. Barclays Capital strategists, who expect a demand of some 350 million euros at the three-year tender, see any further drop in the futures prices as a buying opportunity on the view that the improved mood will continue to drive Euribor rates lower. They see Euribor rates fixing within the 90 basis points area in one month's time and falling to the 75/80 bps area by the European summer. On Tuesday, three-month Euribor rates hit their lowest since Jan. 2011 at 1.051 percent. Equivalent euro London-fixed Libor rates fixed at 0.98286 percent versus 0.98614 percent on Monday.