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MONEY MARKETS-Scope for further drop in euro rates seen limited
LONDON Aug 28 (Reuters) - Euro zone interbank lending rates plumbed new lows on Tuesday as weak lending data fuelled expectations the ECB will cut interest rates as soon as next week, but the decline may not have much further to go.
Three-month Euribor rates have collapsed from around 1.5 percent late last year to just 0.29 percent on Tuesday, a result of the European Central Bank flooding banks with longer-term loans and resuming interest rate cuts.
"The current level incorporates already expectations of a cut in the refninancing rate at the September meeting," said Barclays Capital rate strategist Giuseppe Maraffino.
"Room for a further decline is limited."
The ECB is expected to cut its record low refinancing rate by a further 25 basis points to 0.5 percent on Sept. 6, according to a Reuters poll of economists.
Bolstering the case for a rate cut, data showed loans to households in the euro zone, which is on the brink of recession, fell in July, reflecting weak domestic demand.
Loans to companies ticked up only slightly, suggesting a credit squeeze persists despite banks being stuffed with record amounts of central bank funding.
Commerzbank rate strategist Benjamin Schroeder said the downward trend in Euribor rates may pause after the ECB meeting. He saw only a small amount of room for further falls if the central bank leaves its refi rate at 0.75 percent.
"If the ECB keeps the refinancing rate on hold, we still see some scope to the downside (for Euribor), maybe not to the degree we're seeing now but the zero rate argument is still strong and could bring rates down."
Schroeder does however see room for a more substantial fall if the ECB cuts rates as expected, basing his case on the prices banks are submitting to the panel that sets the Euribor rates.
The lowest quote submitted on Tuesday was 0.16 percent, while the highest was 0.42 percent.
"When we saw the trough in rates in 2010, there was a very strong skew to the lower rates, whereas now we are still pretty much distributed towards the middle, or even the high end," Schroeder said.
He said the three-month Euribor rate could fall as low as 0.18-0.20 percent in the second half of September.
One technical factor that may prevent this, however, is the spread between Euribor rates and Eonia overnight interbank lending rates.
That three-month spread has fallen to all time lows on a forward basis of around 17 basis points, something Maraffino already sees as overdone.
"These are very, very tight levels...and reflect an improvement in sentiment with the market knowing that the ECB is ready to intervene," he said.
"That reduces liquidity concerns and risk in the European banking sector so we're seeing this compression but room for further tightening is quite limited."
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