Banks scramble for euros as year-end nears

Tue Dec 10, 2013 10:58am EST

* Three-month eurodollar cross currency swaps turn positive

* Banks withholding cash worsen liquidity squeeze

By Emelia Sithole-Matarise

LONDON, Dec 10 (Reuters) - European banks are paying a higher premium to swap dollars for euros in money markets, reflecting a squeeze on liquidity as the year-end approaches and as banks stash cash before a European Central Bank review.

The three-month euro/dollar cross currency basis swaps turned positive for the first time since 2008 on Monday. The cost of swapping dollar-denominated interest payments into euros was last at 2.75 basis points. Hitherto, banks have paid a premium to swap euros for dollars.

Excess cash in the euro financial system has been dwindling in recent months, pushing up short-term money market rates, as banks repay cheap three-year loans handed out by the ECB at the height of the debt crisis in 2011 and 2012.

Exacerbating tight conditions in money markets, banks are also holding on to cash in anticipation of the ECB's "Asset Quality Review", which will assess whether banks have properly valued loans in key areas of their business.

The flip in the basis swap shows euro zone banks are now paying the lowest cost since 2008, when the financial crisis exploded, to swap euro payments into dollars.

Money markets are still flush with dollars with the U.S. Federal Reserve yet to trim its monetary stimulus.

"Driving this 'euro premium' we presume are the same factors driving euro interbank rates higher into year-end," said Chris Turner, head of currency strategy at ING.

"Euro zone commercial banks, facing a snapshot of their balance sheets being taken as of 31 December 2013 for the Asset Quality Review, are continuing to de-leverage."

The grind higher in money market rates pushed the euro to a six-week high against the dollar of $1.3795 on Tuesday. The rise in market rates accelerated after the ECB gave no hint last week that it would soon ease monetary policy further after cutting its main refinancing rate in November.

After the bank kept rates on hold last Thursday, ECB President Mario Draghi said he was satisfied with levels in the money markets.

Resurgent borrowing costs could hurt a fragile economic recovery in the euro zone. While other ECB officials have reiterated the ECB still has steps it can take, such as cutting its overnight deposit rate below zero if needed, the increasing tensions in money markets reflect some scepticism.

MARKET SCEPTICISM

Many in the market say taking overnight deposit rate into negative territory, effectively charging banks to park their cash with the ECB, could prove counterproductive and tighten money market conditions even more as banks seek to reduce the excess cash they hold and seek to pass on their extra costs.

Another dose of cheap long-term loans for banks looked less imminent too while banks were still paying back the 1 trillion euros in financing they got at the peak of the debt crisis.

"There's some scepticism in the market as to just how many effective monetary policy options the ECB really does have at its disposal," said ICAP strategist Chris Clark.

"Heading into 2014, unless the ECB is willing to take rather dramatic or inventive action, we are probably unlikely to see any easing in money market rates."