MONEY MARKETS-Steady ECB seen, focus shifts to cash repayments

Mon Nov 5, 2012 8:25am EST

* Markets price a steady ECB

* Effect of any surprise rate cut seen limited

* Focus shifting to excess cash repayments

By Kirsten Donovan

LONDON, Nov 5 (Reuters) - Euro zone money markets aren't expecting the ECB to alter policy this week, leaving the focus on whether banks will start next year to repay excess cash they have borrowed from the central bank or just keep hoarding it.

Markets have all but priced out the possibility the European Central Bank will cut the rate it pays to deposit cash overnight from its current zero percent and economists polled by Reuters expect the main refinancing rate to be kept at 0.75 percent on Thursday.

ECB officials have indicated the central bank doubts another rate cut would have much impact on the economy, leaving the focus on unconventional measures such as the cheap long-term liquidity it has pumped out over the past year and the bank's new bond-buying option.

"You can understand how the market is interpreting that it won't be conventional measures that will be the way forward for boosting confidence ... and is moving away from expecting further rate cuts," said Credit Agricole rate strategist Orlando Green.

The euro zone debt crisis has abated since the ECB detailed a plan to buy the bonds of struggling euro zone countries if they ask for aid. Spain is seen as the most likely candidate although it has yet to make a move.

Forward overnight Eonia rates - which reflect expectations of where the deposit rate will be set - are at most just a couple of basis points below current levels, indicating markets see the rate staying at zero percent.

"We think the ECB will shy away from cutting the deposit rate into negative territory," said Commerzbank rate strategist Benjamin Schroeder.

Although a negative deposit rate may spur banks to lend more, it deters money market funds and some, such as BlackRock Inc - the world's largest money manager - have restricted investor access to European funds.

It is, however, much harder to measure expectations of a refinancing rate cut because the near 700 billion euros of excess cash banks are currently holding distorts the traditional calculations used before the financial crisis.

Even if the ECB does surprise on Thursday by cutting the refinancing rate, reaction in money markets would likely be somewhat subdued with overnight rates pinned by deposit rate expectations.

Euribor interbank lending rates could fall further, analysts said, but the move may be limited with the spread over equivalent maturity Eonia rates having already collapsed to just 10 basis points - nearing levels seen before mid-2007. Eonia rates in theory strip out the risk of a lender or borrower defaulting.

The three-month Euribor rate resumed its downtrend on Monday, inching down to 0.196 percent, but has shown signs of bottoming out with unchanged fixings late last week.

With little prospect of rate cuts, markets have turned their attention to how much of their excess cash - borrowed at three-year tender operations in December and February - banks will repay with some estimates putting the figure at 200 billion euros.

"Looking at forward Eonia rates, markets don't expect an amount of liquidity to be drained that will have an impact on rates," said Commerzbank's Schroeder.

"It's only once excess liquidity drops below 100 billion euros that you see an impact on the Eonia fixings," he added.

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