MONEY MARKETS-Irish bailout fails to relieve funding tensions

Mon Nov 29, 2010 7:57am EST

 * Banks funding remains pressured despite Irish rescue 
 * ECB faces exit strategy dilemma this week
* Eonia now seen above 1 percent in Nov. 2011
 
 By Kirsten Donovan and Emelia Sithole-Matarise
 LONDON, Nov 29 (Reuters) - Peripheral euro zone banks
funding conditions remained pressured on Monday as a bailout
package for Ireland failed to draw a line under debt concerns,
leaving the ECB with a tricky decision to make later this week.
 Irish government bond yields fell on Monday after the
European Union approved an 85-billion-euro rescue for Ireland
and outlined a permanent system to resolve Europe's debt crisis.
 But elsewhere on the periphery, the news was received more
cautiously with yields on Spanish 10-year debt rising as the
moves did little to reduce expectations that Portugal -- whose
banks are heavily reliant on European Central Bank (ECB) funding
-- and possibly Spain, would also need financial assistance.
 That leaves the ECB with a dilemma, as it has promised to
tell markets this week whether or not it will continue to
withdraw the extraordinary liquidity provision measures put in
place during the financial crisis. 
 "There's a lot of evidence that the crisis is not over and
that there are still a lot of banks remaining dependent on ECB
liquidity and not only in Greece and Ireland but also in some
stronger countries such as Germany," said Patrick Jacq, a
strategist at BNP Paribas.
 Jacq and other strategists expect the liquidity-sensitive
Eonia EONIA= overnight rate to fall as low as 0.37 percent by
the end of the current ECB reserve maintenance period next week,
after rising as high as 0.80 percent around Nov. 10 when the
maintenance period began. The overnight rate traditionally sits
above the ECB's refinancing rate. Eonia EONIA= fixed at 0.446
percent  on Friday.
 Forward markets were now showing overnight EONIA rates
rising above the ECB's key refi rate currently at 1 percent by
November compared with July last week.
 "It is looking increasingly possible that the (ECB)
Governing Council might elect to postpone a decision on further
exit measures until the first quarter of 2011," Barclays Capital
strategists said in a note.
 "There would not be much cost in agreeing to a postponement,
in order to avoid possible inflammation of the currently
prevailing market stress.
 
 FUNDING TENSIONS
 Until market stress intensified last week, the prevailing
market view was that the ECB would switch its tenders of 3-month
money back to a variable rate, limiting the amount on offer,
albeit possibly to much more than banks actually need. 
 The escalation of euro zone tensions has pushed the cost of
raising funds in secured lending markets higher in recent weeks.
 The five-year euro/dollar cross-currency basis swap
EURCBS5Y=ICAP, which shows the rate charged when swapping euro
interest payments on an underlying asset into dollars, fell to
-36 basis points on Friday, near the -39 bps reached in May when
Greece had to take funding from the International Monetary Fund
and EU indicating a reluctance to swap dollars for euros.
 It was last at around -36.5 bps, showing little relief after
the weekend's events.
 Some pressure on banks eased however, after the EU opposed
making senior bank bondholders share the bailout burden by
taking write-downs.
 The cost of insuring senior financial debt against default,
as measured by the iTraxx senior financials index ITEFA5Y=
pared early tightening to stand 2.5 bps lower on the day at 162
bps, according to data monitor Markit.
 "This will provide relief to the markets, and should also
give support to paper of Portuguese and Spanish banks," BNP
Paribas credit strategists said.
  Benchmark three-month euro Libor rates EUR3MFSR= slipped
to 0.96750 percent from 0.96875 percent with equivalent dollar
rates USD3MFSR= barely changed at 0.29594 percent. For latest
Libor fixings see [ID:nEAP000020]
 (Editing by Susan Fenton)


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