UPDATE 2-Latest spike in euro money rates keeps pressure on ECB

Fri Jan 17, 2014 11:09am EST

Related Topics

* Eonia hits 0.30 pct, above ECB's 0.25 pct refi rate

* Falling excess liquidity putting pressure on rates-analysts

* Low ECB loan repayments next week may offer some respite

By Marius Zaharia and Marc Jones

LONDON, Jan 17 (Reuters) - Pressure on the European Central Bank to ensure rising borrowing costs do not snuff out the euro zone's fledgling recovery crept higher on Friday as they rose above its benchmark for the third time in as many months.

At the ECB's last meeting, President Mario Draghi said an "unwarranted" rise in the bank-to-bank lending rates that underpin borrowing costs across the economy would be one of the triggers for another rate cut or more drastic action.

Eonia, the euro zone overnight bank-to-bank lending rate, settled at 0.30 percent overnight, up from 0.21 percent the previous day and from between 0.10 and 0.15 percent last week.

The rise pushed Eonia back above the ECB's headline 0.25 percent rate that banks pay when they borrow at the central bank's still-unrestricted lending operations.

It was the first time this year but the third time since November.

Analysts say it is a symptom of falling excess liquidity -money banks have beyond what they need for their day-to-day operations.

Banks have already paid back almost half of the 1 trillion euros the ECB flooded into the system at the peak of the crisis. Excess liquidity is now down to just over 130 billion euros, its lowest since September 2011 and down from a mid- 2012 peak of 800 billion.

"Money market rates ... continue to see upward pressure, as liquidity conditions gradually tighten, which will put more pressure on the ECB to make a move," said Jan von Gerich, chief fixed income analyst at Nordea in Helsinki."

The ECB wants to prevent such a rise in short-term rates because it would effectively tighten monetary conditions, putting pressure on economic growth and potentially pushing the euro zone's already sub-target inflation even lower.

REPAYMENTS EASE

The focus is now on whether banks look to self-regulate market rates themselves by taking more from the ECB when it holds its weekly and 3-month lending operations in the next couple of weeks.

There looked to be signs of it already on Friday as banks paid back just 991 million euros of the near 540 billion euros that remains of the ECB's 1 trillion euro, 3-year LTRO bonanza.

"At least it argues against Eonia spiking further up," said Marius Daheim, chief strategist at Bayerische Landesbank.

Chris Clark, a strategist at ICAP added that market prices also pointed to self-regulation taking place.

"With 1-month Eonia closing around 0.21 percent yesterday evening, this surge in short-term borrowing rates is expected to pass, although probably not until next week's main refinancing operation," he said, adding that things such as tax deadlines in Italy would keep the pressure on till then.

But others say longer-term money rates trading lower than overnight ones suggested market participants were also expecting some form of additional ECB policy action this year.

The forward interest rate market [ECBWATCH showed Eonia was expected to trade at 0.19 percent after the February meeting and as low as 0.15 percent at the end of the year.

Top ECB policymaker Benoit Coeure gave little sign in an interview on Thursday that anything was imminent, though he repeated that the bank has room to cut its interest rates further or offer out more cheap liquidity.

"If we continue to see Eonia well above 15-20 basis points in coming weeks the ECB will probably feel forced to take remedial action," Rabobank market economist Elwin de Groot said. "That could be already in the next meeting."

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