* Eonia falls to 0.152 from end-year level of 0.446 percent
* ECB seen comfortable with current levels
* Eonia rates might tick higher later this year
By Marius Zaharia
LONDON, Jan 3 A plunge in euro zone money market
rates at the start of 2014 following a year-end jump has eased
pressure on the European Central Bank to relax its monetary
policy still further, but the upward trend may resume in the
next few months.
Movements in Eonia, an average of interest rates at
which euro zone banks lend to each other overnight, have been
extraordinary this week by the standards of the money market,
which usually rises and falls in tiny increments.
Eonia surged to a two-year high of 0.446 percent at the end
of 2013 as thin liquidity forced banks to overpay for cash,
before falling back to 0.152 percent when markets returned to
Eonia traditionally rises sharply on the last trading day of
each year when banks need to meet year-end cash targets and
liquidity is thin. However, the 2013 peak was almost double the
ECB's official refinancing rate of 0.25 percent at which it
lends funds to the commercial banks.
This has raised worries that Eonia could trade much higher
in 2014 than in past years, even though the ECB has flooded the
banking system with cash to bring overnight rates to ultra low
levels and help the euro zone recover from its debt crisis.
Higher money market rates effectively tighten the monetary
conditions which the ECB loosened only in November when it cut
the refinancing (refi) rate to its current record low. A
prolonged rise in market rates could endanger the economic
recovery, which, based on manufacturing surveys on Thursday and
unemployment data on Friday, shows signs of picking up.
Stimulating economic growth is vital for the ECB's goal of
avoiding a damaging bout of deflation and lifting inflation from
a currently low level back towards its target of just below two
percent. Stronger growth would also help countries with lower
credit ratings, such as Italy and Spain, to cut their overall
debt and put the euro zone crisis to bed.
If Eonia holds around 0.15 percent, this should not create
much discomfort for the ECB as it would lie roughly at the mid
point between the refi rate and the deposit rate, at which banks
park excess cash at the central bank overnight.
This would allow ECB policymakers to keep official rates
unchanged when they meet next week, barring any sharp fall in
inflation when December data are released on Tuesday, analysts
said. "They're not going to jump the gun," said Harvinder Sian,
rate strategist at RBS. "But they probably won't be too tolerant
of much higher levels."
SCRAMBLING FOR CASH
Eonia's year-end spike should still not be ignored, analysts
said. In 2012, a rise to 0.13 percent was followed by a drop to
0.06 percent on Jan. 2, 2013, significantly lower levels than
This is partly the result of banks repaying early some of
the more than 1 trillion euros of three-year crisis loans
offered by the ECB under its Long Term Refinancing Operations
(LTROs) at the height of the debt crisis in late 2011 and early
These repayments caused the excess cash in the banking
system - money beyond what banks need for their day-by-day
operations - to shrink from over 800 billion euros in March 2012
to about 275 billion euros at the end of last year.
Such repayments are expected to continue, and the less
excess cash in the system, the higher the chances that banks may
need to borrow more from other banks, pushing up money market
The banks are now particularly keen to show they are less
reliant on ECB loans and can raise more funding in the market.
This is because the ECB is conducting an "asset quality review"
(AQR) this year, part of a drive to check the health of euro
zone lenders before it takes over supervising the most important
banks from national bodies in late 2014.
Their wish to have more liquidity on their books for a
year-end snapshot to be used in the review may have also
contributed to the Eonia surge, some analysts said.
"The AQR, the end-year effect and the repayment of LTRO
money led to such a significant spike," Rabobank market
economist Emile Cardon said.
Banks scrambling for cash meant that on Dec. 30 the ECB was
able to drain only 104.8 billion euros of the 178.5 billion it
usually takes out of the system every week.
The draining operations aim to compensate for money the ECB
pumped into the system under its Securities Markets Programme
(SMP) when it began buying bonds on the debt market at the start
of the crisis.
They were introduced to quell concerns, particularly in
Germany, that the SMP would be inflationary and lead to the ECB
directly financing government budget deficits, which it is
forbidden from doing under European law. Draining operations are
expected to resume in full in the next few weeks.
"The relatively comfortable excess liquidity cushion might
decrease when LTRO repayments pick up again and when the SMP
absorption failure is taken away from the excess reserves,"
Commerzbank rate strategist Benjamin Schroeder said.
Schroeder expects market rates to rise again in 2014,
although he does not believe the ECB will react to this as the
economic recovery might withstand tighter monetary conditions.
However, he says speculation about further ECB easing is likely
to pick up later this year.
The ECB has a number of options, Sian at RBS said. It could
cease withdrawing SMP money, halve the minimum level of liquid
reserves that banks are required to hold - releasing 50 billion
euros into the system - or provide more funding in the form of
new LTROs with different features.