5 Min Read
* Banks take up only 3.7 bln euros in 3-month funds
* Shows banks not swapping 3-yr loans for short-term funds
* Rise in short-term rates overdone, some analysts say
By Emelia Sithole-Matarise
LONDON, Jan 30 (Reuters) - Money market rates marched higher on Wednesday after banks passed up twin opportunities this week to replace three-year loans with shorter-term funds, fostering concerns excess cash may start dwindling faster than predicted.
Banks took up only 3.7 billion euros of three-month funds at the European Central Bank's financing operation on Wednesday, less than half the 10 billion average forecast in a Reuters poll.
On Tuesday, they rolled over slightly less than 125 billion euros in seven-day funds at the ECB's weekly tender. The lack of a pickup in demand at both operations signaling that banks were not simply shifting the 137 billion euro in three-year loans they repay on Wednesday into shorter-dated funds.
Many in the market see this as a sign of healing in parts of the crisis-hit euro zone banking sector but lessening cash in the system means monetary conditions are effectively tightened, pushing short-term money market rates up.
The results of the twin ECB tenders and the initial repayment of the ECB's three-year long-term refinancing operation (LTRO) leave about 500 billion euros of excess liquidity in the banking system.
While this is still quite ample and will keep key overnight Ionia bank rate around current record lows, uncertainty over how much excess cash will be drained from the system as banks repay the three-year funds weekly has jacked up wholesale bank funding prices.
"The market is pricing the scenario of big repayments, a reduction in liquidity surplus and a tightening of liquidity conditions. So the big repayment announced last week and this week's tenders supported such expectations," said Giuseppe Maraschino, a strategist with Barclays Capital.
"Markets now will be very sensitive to the weekly repayments and all data on liquidity conditions, but I don't expect Ionia fixing to be significantly affected by the three-year LTRO repayments so I don't expect it to go up as the market is pricing now," he said.
Overnight Ionia forward contracts, which lock in an overnight borrowing rate over a longer period, remained under pressure. One-year Ionia rose as high as 0.25 percent from around 0.23 percent before the results of the ECB three-month tender.
Bank-to-bank Euribor lending rates fixed at 0.23 percent from 0,.226 percent, with equivalent Libor rates also edging higher, while Euribor futures pointed to higher rates from the end of 2013 out to 2017.
Wholesale bank funding prices have been rising since the announcement on Friday that banks would repay this week a higher than forecast 137 billion euro of the three-year loans that the ECB said averted a credit crunch in late 2011 and early 2012.
Stabilizing euro zone markets and the perception the ECB was starting to tighten monetary conditions while other major banks such as the Federal Reserve and the Bank of Japan were still pump-priming, has also buoyed the euro, which spiked to a 14-month peak of $1.3563 on Wednesday.
"There's some unwinding of trades which were in play before the start of the year, possibly positioning for a rate cut and very dovish monetary policy so they have to cut their position," said Patrick Jack, a strategist at BNP Paribas in Paris.
"And we probably have some speculative flows now betting on a more hawkish monetary stance which to me doesn't make any sense but in the near term this is the bias and there could be a correction at some stage."
Jack, Maraschino and other analysts reckon, however, that the rise in money market rates seemed overdone, particularly with excess liquidity still expected to remain ample enough to temper a sharp rise. Historically, money market rates only tend to move freely once the cash surplus drops below 200 billion euros, a scenario largely viewed as unlikely with banks expected to repay a total of 300 billion euros of the three-year funds this year.
Money market rates effectively determine what interest rates banks charge firms and consumers and a sudden spike in rates could put unwanted stress on the euro zone's fragile economic recovery.
The latest ECB survey showed that banks made it harder for firms to borrow in the fourth quarter and expect to tighten loan requirements further in coming months even though their own funding constraints have eased. (Chris Pizzey, London MPG Desk, +44 (0)207 542-4441)