* Draghi strengthens message on potential for more easing
* Euro falls to 5-week low vs dollar, 1-yr low vs sterling
* Analysts still warn thinner liquidity may push rates up
By Marius Zaharia and Patrick Graham
LONDON, Jan 9 Euro zone money market rates fell
and the euro currency weakened on Thursday after the head of the
European Central Bank gave his clearest message yet about what
could trigger further monetary easing.
President Mario Draghi laid down two triggers for further
action, saying the ECB would try to fight further falls in
inflation or an unwarranted rise in money market rates.
His more specific guidance on future moves came after euro
zone inflation slowed to 0.8 percent in December, much lower
than the ECB's target of nearly 2 percent, and as signs of a
pick-up in growth and falling excess cash levels in the banking
sector had begun to nudge short-term rates higher.
The ECB wants to avoid a rise in money market rates - rates
at which banks lend to each other and which set the baseline for
the cost of lending across the economy - as that would
effectively tighten monetary conditions, limiting the potential
for economic growth and pushing inflation even lower.
"This is bold talk from the ECB and suggests that the bank
means business," said Kathleen Brooks, head of research at
Forex.com. "The rose-tinted glasses have been thrown off and
Draghi and co will not be moved from their dovish path even
though there have been further signs that the currency bloc is
turning a corner and returning to growth."
The euro hit a five-week low of $1.3548 and, against
sterling, a one-year low of 82.30 pence in reaction
to Draghi's comments.
The euro later recovered somewhat but many analysts say the
divergence in policy outlooks between the world's major
economies will weigh heavily on the single currency this year.
Money market rates implied by Euribor futures in
2014 and 2015 fell by up to 3 basis points, while German
two-year bond yields dropped 2.6 bps to 0.21
percent, before rebounding slightly. German Bund yields, the
benchmark for euro zone long-term borrowing costs,
were little affected by Draghi's remarks.
His signals were likely to support this year's strong rally
in lower-rated bonds as rock-bottom interest rates encourage
investors to maximise their returns by buying riskier assets.
Portuguese bonds were standount performers. Ten-year yields
fell 3 bps to 5.40 percent, as Lisbon drew solid
demand for a 3.25 billion euro five-year bond sale on Thursday.
French yields rose as the national audit office said the
country's debt level was in the "danger zone."
Draghi also tried to play down the relationship between
money market rates and excess liquidity, which is money banks
have beyond what they need for their day-by-day operations.
Analysts say the less liquidity in the system, the more
likely that banks will need to borrow cash from other banks,
putting upward pressure on money market rates.
The euro overnight lending rate rose to 0.137
percent on Wednesday from 0.099 percent the previous day as the
excess liquidity dropped to 157.4 billion euros from 279
billion. The average Eonia rate for 2013 was 0.09 percent.
Forward Eonia rates for the next two years
dropped a few basis points after Draghi's comments, though.
"He went out of his way (to talk down short-term rates)... I
didn't find his arguments too convincing, but his dovish
guidance would have helped to limit the damage on forward
rates," Societe Generale strategist Ciaran O'Hagan said.
Banks this week took one-week loans of 112.5 billion euros
from the ECB, while loans for 168.7 billion expired, draining
56.2 billion from the system. The ECB also absorbed the entire
stock of 179 billion euros of its sovereign bond purchases,
after failing to drain the whole sum at the end of 2013 when
liquidity was thin, taking out a further 74 billion.
The ECB is holding weekly tenders to hoover up the cash
injected into the system when it bought bonds at the height of
the crisis, in an effort to ease concerns about direct state
financing, something it is not allowed to do.
Excess cash is expected to drop further as repayments of the
ECB's three-year crisis loans taken in late 2011 and early 2012
resume next week.
"It is something to watch," said ICAP strategist Philip
Tyson. "If it falls (below) 100 billion and Eonia is ticking
towards the ECB's refinancing rate (of 0.25 percent), this will
increase speculation of (further easing)."