* 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
(Updates prices, adds new quotes)
By John Geddie and Marius Zaharia
LONDON, June 10 Euro zone overnight bank-to-bank
interest rates traded at record lows on Tuesday and short-term
bonds outperformed longer-dated paper in a sign that the
European Central Bank's efforts to keep money markets anchored
may bear fruit.
A measure of the market's inflation expectations, derived
from the difference between the yields of index-linked debt and
conventional bonds - the euro five-year, five-year breakeven
forward - was near three-month highs, showing increasing
confidence in the ECB's resolve to accelerate price growth.
While it was still early days, strategists said the market's
response to last week's cut in the ECB's main interest rates and
its promise of fresh liquidity for banks suggested the measures
could work. The moves could go further in the coming days as the
ECB measures come into effect.
"Everything that has happened in the market is in line with
what the ECB would have hoped for," said David Keeble, global
head of fixed income strategy at Credit Agricole. "The ECB is
getting in front of the curve again."
Spot Eonia fixed at 0.053 percent after markets
closed on Monday, a new historic low.
The five-year, five-year breakeven forward rate
, which is one of the ECB's favourite tools for
gauging the market's inflation expectations, traded around 2.13
percent, some 3 basis points up from before the ECB meeting.
It moved further away from lows of just above 2 percent hit
in May after below-forecast inflation data.
The amount of cash euro zone banks have beyond what they
need for their day-to-day operations is a key factor holding
short-term rates low. Excess liquidity stands at
120 billion euros, well above the three-year low of 70 billion
euros hit at the end of last month.
A smaller take-up from banks at the ECB's weekly liquidity
offerings on Tuesday will squeeze 25 billion euros out of the
banking system for the coming week, but the impact is expected
to be limited and in any case temporary.
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 euros 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.
ECB 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 expectations the
ECB will keep the market pinned down, while six-month contracts
dated for 12 months from now are low enough to suggest further
policy loosening, say strategists.
Investors' preference for short-dated German bonds over
longer-dated ones is further evidence of confidence in what the
ECB can achieve with its latest measures.
Two-year German yields fell slightly to 0.06
percent. Ten-year yields, the benchmark for euro
zone borrowing costs, rose 2 bps to 1.40 percent.
"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.
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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 members.
Yields on 10-year Greek bonds dropped to as low
as 5.48 percent, 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.
The Republic of Cyprus - bailed out just last year - is set
to meet investors ahead of a possible euro bond issue, IFR
(Editing by Catherine Evans and Nigel Stephenson)