* Spot Eonia falls to record low
* ECB rate cut, liquidity injection still to take effect
* Forward breakevens rise with inflation outlook
* Greek yields drop, Cyprus plans comeback
(Adds fresh quotes, updates prices)
By John Geddie
LONDON, June 10 Euro zone overnight interbank
interest rates traded at record lows on Tuesday in a sign that
the European Central Bank's efforts to keep money markets
anchored will bear fruit.
Strategists said markets were adjusting to last week's cut
in the ECB's main interest rates and its promise of fresh
liquidity for banks, which should see rates fall even lower when
these measures come into effect this week and next.
"The ECB has given very strong forward guidance for the
first two years, and all its measures work to pin front-end
rates," said Michael Michaelides, rates strategist at RBS.
Spot Eonia fixed at 0.053 percent after markets
closed on Monday, dropping below the previous historic low set
in February 2013.
Some argue, however, that the move could be short-lived,
with low trading volumes during European holidays on Monday
creating a slight anomaly.
"The drop could be psychological but I don't find that very
satisfactory because the new rates do not yet apply," said
Christoph Rieger, a strategist at Commerzbank.
"We have observed in the past that during German holidays
when volumes fell, Eonia fixings also declined."
Rieger expects Eonia to fix higher on Tuesday and start to
fall after the European Central Bank implements cuts in its main
rates on Wednesday, imposing for the first time charges on cash
parked by banks at the ECB.
The excess liquidity in the banking system will also keep
downward pressure on short-term rates.
Excess liquidity stands at 120 billion euros,
well above the three-year low of 70 billion euros hit at the end
of last month, although the ECB took a further 25 billion euros
from its cash offerings on Tuesday.
From next week, the ECB will inject around 170 billion euros
into the banking system by halting tenders that withdrew funds
spent on past government bond purchases.
It has also introduced 400 billion euro ($544.86 billion) of
ultra-cheap four-year loans for banks - conditional on their
lending to the smaller companies that are Europe's economic
backbone - which will be available from September.
European Central Bank Governing Council member Erkki
Liikanen reiterated on Tuesday that the ECB still has tools it
can employ if needed.
Forward Eonia rates are already pricing in the ECB's ability
to keep the market pinned down, while six-month contracts dated
for 12-months time are low enough to suggest further policy
loosening, say strategists.
The fall in Eonia rates was partly behind a fall in the euro
against the dollar and yen on Tuesday,
WEAK LINKS FLOURISH
Market confidence in the ECB's ability to nurture growth and
reflate the economy has been evident in an uptick in forward
breakevens over the last few days.
Expectations of an eventual rise in consumer prices should
bode well for France which hired a group of banks to sell a new
15-year inflation-linked bond on Tuesday.
In German government bonds - a benchmark for euro zone
borrowing - these expectations can also be shown by investors'
preference for short-dated benchmarks over longer maturities,
which led to further curve steepening on Tuesday.
The ECB's pledge to keep rates at historic lows for some
time has, however, fuelled demand for the higher-yielding bonds
of some of the bloc's weakest links.
Yields on 10-year Greek bonds dropped 24 bps to
5.53 percent on Tuesday, a level not seen since January 2010,
while Portuguese equivalents were within a whisker of euro era
lows after dropping 14 bps to 3.24 percent.
These new lows raise the prospect that Greece, which
returned to markets in April for the first time since 2010,
could soon issue more debt to help to stave off the need for a
third bailout, Commerzbank said in a note on Tuesday.
The Republic of Cyprus - bailed out just last year - is set
to meet investors ahead of a possible euro bond, IFR reported on
Elsewhere, Italy's 10-year yields rose 2 bps to
2.72 percent from Monday's record low while Spain's
dropped 3 bps to a new low of 2.56 percent.
(Editing by Catherine Evans and Nigel Stephenson)