MONEY MARKETS-Volumes in overnight euro zone lending plunge

Tue Dec 4, 2012 10:34am EST

* Eonia volumes drop by a third y-o-y in November

* Traders note increased activity in longer-term rates

* But overall volumes still subdued, euro crisis weighs

By Marius Zaharia

LONDON, Dec 4 (Reuters) - Euro zone banks have cut their overnight lending to each other in favour of longer-term loans but still lack the confidence to be more active in money markets due to concerns about the bloc's debt crisis.

Since the European Central Bank cut the rate on its deposit facility to zero in July, driving overnight Eonia rates to just a few basis points, some banks have opted to lend for longer periods, trying to attract higher interest rates.

That led to a drop in overnight volumes, with traders saying the move offset the greater activity in longer-term rates.

The fact that overall lending volumes is unchanged indicates there has been no fundamental improvement in the confidence banks have in each other and that lenders are only taking more risk because they want a slightly higher return on their cash.

"It's mostly moving peas on the same plate. Nobody is doing much," a money market trader said. "The whole of Europe is not exactly in equilibrium and that state seems to be quite stable at the moment."

He said the ECB's massive cash injections have left many euro zone banks with more liquidity than they need. Their cautious stance makes them hold on to cash rather than lending them to other banks or to businesses.

The daily average volumes in trades using the overnight Eonia rate was about 20 billion euros in November, down by a third from the same month of last year, according to Reuters calculations. They have declined from 23.6 billion in October and 26.3 billion in September.

Another trader said most of the activity is still in maturities of less than three months, with the rest of unsecured lending largely frozen.

Despite reassurances from policymakers that they will do whatever necessary to save the euro zone, money markets remain closed for many banks in the bloc's lower-rated states.

Eonia rates settled at 0.077 percent on Monday. The benchmark three-month interbank Libor rate for euros settled at 0.12714 percent on Tuesday.

TRANSMISSION

The low money market rates are not being transferred to the real economy. Banks are not confident of their own market access longer term and therefore not lending to businesses.

Loans to the private sector fell by 0.7 percent in October from a year before, the latest ECB data shows.

ECB President Mario Draghi proposed a central bank sovereign bond buying programme named OMT, or Outright Monetary Transactions, as a way of better transmitting the bank's ultra-loose monetary policy to the crippled euro zone economy.

The idea behind it is to bring down indebted countries' short-term borrowing costs and ease their debt burdens. As long as sovereigns can stay afloat the chances of a banking sector meltdown are reduced.

The OMT activation -- pending a request for a bailout from one of the euro zone states, most likely Spain -- is expected to further encourage banks to take more risks in lending markets.

But without a reduction in overall euro zone debt levels and more reforms to fix the bloc's underlying economic problems, banks are unlikely to suddenly start lending more to the real economy, analysts say.

"In case of activation of the programme there might be a slight improvement (in money market sentiment)," Barclays Capital rate strategist Giuseppe Maraffino said. "But it will not be a normalisation of the market. It would all still be based on ECB support. Normal markets function on their own."

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