MONEY MARKETS-Rise in euro rates pauses, unlikely to reverse

Fri Feb 8, 2013 10:30am EST

* Long-term euro money market rates stable

* Rates unlikely to fall back to last year's levels

* LTRO repayment pace key for future moves

By Marius Zaharia

LONDON, Feb 8 (Reuters) - Euro zone money market rates stabilised on Friday, in a sign ECB chief Mario Draghi's attempt to temper a recent rise was working, though his remarks were not seen strong enough to put rates back on a downward path.

Draghi said on Thursday he would monitor money markets to ensure policy remains "accommodative".

He estimated that even after the initial repayments of the second of the European Central Bank's LTRO crisis loans, expected at the end of the month, excess liquidity would not drop below 200 billion euros -- the level at which overnight borrowing costs typically begin to rise.

The comments pushed longer-term money market rates lower by 3-5 basis points on Thursday. On Friday, one-year Eonia contracts were flat at 0.1690 percent, while the two-year rate was slightly higher at 0.2740 percent.

Analysts said Draghi's remarks had cooled expectations about how fast excess liquidity would come down, but did not convince investors rate cuts were on the agenda.

"He probably just capped rates rather then sending them on a downward path," FXPro chief economist Simon Smith said.

"His comments put in the minds of the market the idea that maybe (a cut) could just happen and that maybe they're getting ahead of themselves. But I don't see that as a central scenario. They are aware that it's not without problems."

The ECB left its main refinancing rate unchanged at 0.75 percent and its deposit facility rate flat at zero percent on Thursday.

Analysts say a cut in either rate could be counterproductive by lowering incentives for banks to trade between themselves in money markets, which is the opposite of what the ECB is trying to achieve.

When banks find easy access to funds in money markets they feel more comfortable lending into the real economy. Eonia volumes for January suggested a rise in rates led to an increase in longer-term interbank lending activity.

REPAYMENTS

Key for the path of rates in future is the pace at which banks repay their three-year loans to the ECB taken in December 2011 and February 2012 when the central bank tried to prevent a credit crunch by offering unlimited long-term cash.

The ECB said banks would pay back another 5 billion euros of such loans next week, bringing the total payback of the 489 billion in loans taken in January to 146 billion. The amount was above a 3 billion euros forecast in a Reuters poll.

"This is a decent size, but not on the path to payback at a rate which will impact Eonia this year too much," said Orlando Green, rate strategist at Credit Agricole. He expected one-year and longer rates to keep rising as part of a "normalisation process" in euro zone money markets.

ING strategists recommend a bet that one-month Eonia rates 11 months in the future will be 20 basis points. The trade recommendation was activated at a level of 30 basis points and stops are placed at 35 bps.

The rate was last 25 bps, according to data from Tullet Prebon.

Levels of 30 bps, ING says, are consistent with a reduction of 384 billion euros in excess liquidity, which would be "too aggressive, due to the current uncertainty on the economic growth ... and the political risks in ... Italy and Spain."

The target rate of 20 bps was last seen as recently as mid-January and is way above the negative levels seen in December before the rising trend began in anticipation of a squeeze in excess liquidity, now at around 500 billion euros.

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