Two-year German yields near zero as markets brace for ECB cash
* Two-year German bond yields near one-year lows
* ECB to release 108 billion euros into banking system
* Analysts see slow healing process in money markets
By Marius Zaharia
LONDON, June 17 (Reuters) - German two-year bond yields held close to one-year lows on Tuesday as the market braced for a liquidity boost from the European Central Bank that is expected to keep downward pressure on short-term interest rates.
The ECB effectively releases 108 billion euros into the interbank market on Tuesday - the first time it has not held a weekly deposit tender to neutralise the effect of the bond purchases it made at the height of the crisis.
The outstanding amount of those bonds is 162.7 billion euros, but the ECB failed to drain it all last week.
German two-year bond yields were a tad higher on the day at 0.033 percent, within touching distance of the 0.027 percent hit on Monday, which was the lowest since the end of May 2013.
"This is evidence that the ECB measures are quite effective at least from a market perspective," said Elwin de Groot, senior market economist at Rabobank. "The ultimate impact on the economy remains to be seen."
Germany and the Netherlands sold treasury bills at a negative yield on Monday, the direct result of the ECB cutting the rate it offers banks to keep their money in overnight deposits to minus 10 basis points.
The ECB's move is effectively penalising banks for not putting money to work. Negative T-bill yields means governments will pay investors back less than they borrowed when the paper comes due.
Policymakers hope negative rates in time will force money out of the financial system and into the real economy. But some analysts remain pessimistic.
"If you don't want to lend money to businesses because you don't trust the economic viability of companies you will not do it, no matter what incentives you get from the central bank," said Marius Daheim, chief strategist at Bayerische Landesbank.
"The credit channel is blocked ... People don't trust the economy because growth is feeble, inflation is low, household debt is pretty high and unemployment is high as well."
The total sum of money injected into the market on Tuesday might change depending on how much banks are taking up at the regular ECB offering of one-week loans. Last week, banks took 137 billion euros.
A similar take-up at Tuesday's tender would suggest the euro zone money markets remain fragmented. It would mean the ECB's cash withdrawals had usually been funded by the higher-rated banks in the euro zone's healthier states, while lower-rated peripheral banks remain reliant on ECB liquidity.
At the same time, money fails to flow smoothly from the core banks to the peripheral banks.
"That's what I would expect at this early stage of the new rates regime," Rabobank's de Groot said.
"But the current regime may speed up the process of defragmentation... Some banks, maybe a small percentage, may decide to lend a bit more to the periphery. But we're talking about months, quarters, maybe a year." (Editing by Nigel Stephenson)