RPT-UPDATE 1-Cash drop in the euro zone adds to impetus for ECB action
(Repeats to additional subscribers)
* Spare cash in banking system at lowest since Sept 2011
* Last time liquidity was so low it spurred ECB action
* Quantitative easing still seen as unlikely option (Recasts with money market moves, comments)
By John Geddie and Eva Taylor
LONDON/FRANKFURT, April 24 (Reuters) - The amount of spare cash in the euro zone banking system fell to its lowest levels in 2-1/2 years on Thursday, pushing up short-term money market rates and adding impetus for the ECB to loosen policy further.
The fall in liquidity comes as European Central Bank policymakers have ramped up rhetoric to talk down a strong euro whose resilience could stoke disinflation in the euro zone and torpedo its fragile economic recovery.
ECB President Mario Draghi said weaker inflation could prompt broad ECB asset purchases and the bank could also start charging banks for parking cash with it overnight if there was an undue tightening of its policy stance.
Excess liquidity - which is the measure of money that banks have beyond what they need for their day-to-day operations - fell to 92.937 billion euros ($128.53 billion) on Thursday, the first time it has dropped below 100 billion euros since September 2011.
The last time liquidity fell so low it nudged the ECB to introduce its Long-Term Refinancing Operation, a series of emergency loans to banks.
Now, it is likely to add further incentive for the ECB to act on an "unwarranted" tightening of short-term money markets, one of the scenarios the central bank has said could prompt fresh policy action.
Money market rates came under some upward pressure on Thursday, though expectations of ECB action contained the rise.
The euro zone overnight bank-to-bank lending rate, settled around 0.22 percent, up about 2 basis points from the previous day but still below the rate of 0.25 percent which the ECB charges banks to borrow cash, known as the refinancing rate.
One-year forward rates - the most traded money-market instrument, which shows where one-year contracts are expected to be in a year - spiked 3 bps to as high as 0.24 percent.
"As overnight rates get closer to, or even beyond, the refinancing rate it will be a technical pretext for the ECB to carry out additional measures at its next meeting," said Elwin de Groot, senior economist at Rabobank.
He said this was likely to be a cut in the refinancing rate and a suspension of weekly operations whereby the ECB soaks up money it spent on government bonds at the height of the debt crisis, referred to as sterilisation of the ECB's Securities Market Programme (SMP).
Groot said the ECB was unlikely to embark on a full-blown asset purchase programme, also known as quantitative easing, in the near term because the benefits of that would be slow to come through.
Others said suspension of SMP sterilisation would only be a stop-gap measure to boost surplus cash in the market and keep short-term rates subdued, but that persistent weak inflation would eventually push the ECB into more radical action.
"It (fall in excess liquidity) opens the door for perhaps not quantitative easing now but more liquidity focused action such as suspending sterilization of the SMP permanently," said Benjamin Schroeder, a strategist at Commerzbank.
"This would probably be a short-term solution though, and we would probably see more action later in the year."
BETTING ON ACTION
The ECB next meets on May 8. In the forward market, EONIA rates coinciding with the ECB meetings for the rest of the year remain 2-7 bps below the spot rate, indicating that investors are betting on further policy action.
Not all agree, however, that the fall in excess liquidity is of immediate concern. G+ Economics chief economist Lena Komileva said short-term money market rates are still "well within ranges" and are no trigger for liquidity easing.
"For a policy reaction function, the decline in excess liquidity itself is not a trigger, but the increase in short-term volatility is worth watching," she said. The liquidity decline was mainly driven by banks repaying the long-term crisis funds, which was generally "not a bad thing", she said.
"The stability of medium-term rates suggests that bank deleveraging is working, which makes them less reliant on central bank funding," she said. ($1 = 0.7231 euros) (Writing by Emilia Sithole-Matarise; Editing by Susan Fenton)