* ECB one-week lending drops, falls below forecast
* Excess liquidity set to shrink after LTRO repayments
* Money market pressure tipped to push up short-dated yields
* Long-dated bond yields edge higher in light trading
(Adds fresh quote, updates prices)
By John Geddie
LONDON, July 22 Short-term bond yields could
follow European money market rates higher this week as a drop in
spare cash in the euro zone banking system takes effect, market
analysts said on Tuesday.
Banks took a lower-than-forecast amount of one-week loans
from the European Central Bank on Tuesday, compounding a squeeze
in excess liquidity set to bite when banks repay a bumper 21
billion euros ($28.3 billion) of emergency loans (LTROs) on
Market strategists say depending on other special factors
such as bond expiries, tax payments and holidaymakers taking
cash out of the system, excess liquidity could fall below 100
billion for this first time since May - before the ECB took new
measures to relieve strains in money markets.
"We expect to see some short-term volatility," said Orlando
Green, European fixed income strategist at Credit Agricole.
The euro overnight interbank lending rate edged up
to 0.048 percent on Monday, the upper end of the 2 to 5 basis
point range it has traded in during the last month. Green at
Credit Agricole predicts it will move higher, breaking out of
that range, over the next days.
Two-year yields in Germany - the benchmark for
euro zone borrowing - edged up 1 basis point to 0.04 percent on
Tuesday, and some strategists say these short-dated bond yields
should also track money market rates higher.
Commerzbank strategist Rainer Guntermann said this week's
LTRO repayment is a direct result of the ECB's decision last
month to charge banks to keep their money in overnight deposits.
"You can't force banks to lend," he said, pointing out that
it will take time for policymakers to achieve their goal of
forcing money out of the financial system into the real economy.
The ECB tried to mitigate against a liquidity squeeze last
month by terminating its weekly deposit tender to neutralise the
effect of its crisis bond purchases, but the effects of this
injection have already eased.
Excess liquidity closed at 128.8 billion euros on Monday,
dropping from nearly 170 billion euros at the end of last month.
The combination of a net drop in ECB one-week lending by 2
billion euros and the 21 billion euro LTRO repayment should
alone push excess liquidity close to 100 billion on Wednesday.
However, with the European Central Bank set to offer its
first tranche of new targeted long-term loans in September, few
strategists think this liquidity squeeze will become systemic.
Elsewhere, longer-dated government bonds edged up slightly
across the bloc on Tuesday amid light summer trading volumes.
Traders said the slight underperformance came as the market
digested 6 billion euros of new debt sales in the form of
10-year Belgium bonds and 30-year bonds from the European
Financial Stability Facility, while some investors were
sidelined due to the geopolitical tensions in the Middle East
German 10-year bond yields were 1 bp higher at 1.16 percent,
as were most other core euro zone government bonds and the
lowest-rated bonds in Portugal and Greece.
Spain and Italy were the only countries to see yields fall,
by just a slim 1 bps to 2.56 and 2.77 percent, respectively.
($1 = 0.7417 Euros)
(Editing by Ruth Pitchford)