Relaxed Coeure halts LTRO-related rise in rates

LONDON Fri Jan 18, 2013 11:42am EST

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LONDON (Reuters) - The recent spike in short-term money market rates came to a halt on Friday after a top European Central Bank policymaker played down the chance of banks repaying a massive chunk of their LTRO cash this month.

Banks took more than 1 trillion euros of ultra-cheap, three-year loans from the ECB in two separate offers roughly a year ago as it sought to restore order to Europe's crisis-hit financial system.

They are allowed to start returning the cash in weekly installments from January 30. and as banks must inform it of their plans a week in advance, the ECB will publish the first repayment amount on January 25.

Expectations of the amount to be paid back has increased recently and could be up to 300 billion euros, analysts say, which would effectively halve the amount of excess liquidity in the system.

The heavy oversupply of ECB cash has long depressed the rates banks charge each other on lending markets, but the prospect of a significant repayment and a recent cooling of ECB rate cut hopes has triggered a rise in money market rates.

The one-year Eonia rate reached a peak of 0.2150 percent on Thursday, its highest since early July, while benchmark Euribor rates hit their highest since mid-October on Friday as they rose to 0.209 percent.

The rise was cut short, however, by comments from Benoit Coeure, the board member in charge of the ECB's market operations, who played down the impact on short-term rates of the early LTRO repayments.

"Structurally I don't expect the reimbursement to have a very strong impact on Eonia rates, given the excess liquidity in the euro zone, which remains very high," Coeure told reporters.

Just a month ago markets were flirting with the idea the ECB could cut interest rates and start charging banks to park their spare cash with it. But things have turned almost 180 degrees since Mario Draghi's surprise revelation last week that a rate cut was not even discussed this month.

PAYBACK TIME

"It is all building towards the LTRO payback and whether there will be a big amount repaid," one euro zone-based money market trader who requested anonymity said about the rise in market rates.

"If it is going to be quite modest and less than 200 billion euros it won't really have much of an impact. But if it starts getting up around 300 billion euros, yes, it probably will have a bit of an impact on Eonia."

Analysts at Rabobank said that while both Eonia and Euribor rates would rise if there was a large scale LTRO repayment, Eonia would probably rise more due to the different way the rates price counterparty risk.

German two-year bond yields were dragged up in the market's slipstream on Friday, rising to their highest in nearly 10 months before falling back again as the day progressed and following Coeure's comments.

Shorter-dated bonds were the main beneficiary of the ECB's 1 trillion euros in loans to euro zone banks in late 2011 and early 2012, the cash and record-low official interest rates eventually turning German two-year yields negative.

Even if banks do return much of their LTRO money it may not automatically lead to a sharp drop in the 630 billion euros of excess liquidity currently sloshing round the system.

"It will be interesting to see whether banks pay back a lot of the LTRO money because they want to make it look like they are weaning themselves off central bank support, but then just borrow it back again at the weekly (refinancing operation)," said a trader.

(Editing by Catherine Evans)

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