LONDON Feb 1 A rapid rise in euro money market rates came to an abrupt halt on Friday as the initial flood of crisis loan repayments to the European Central Bank shrank to a trickle.
Having paid back, at the first time of asking, over a quarter of the 489 billion euros ($664 billion) handed out in the ECB's first round of 3-year LTRO loans, banks will return only 3.4 billion next week.
Money market traders polled by Reuters at the start of the week had predicted a 20 billion euro repayment and the much smaller return, after the initial 137 billion euro payback, left many rethinking how quickly the excess of cash in the system would return to a more normal level.
One-year Eonia rates fell below 0.195 percent for the first time this week, having been as high as 0.243 percent before the repayment was announced. The euro also dipped.
The one-year Eonia rate reflects what overnight bank-to-bank lending rates are expected to average out at over the year, and has already risen 0.25 basis points -- the equivalent of a typical ECB interest rate hike -- since December.
"It's fair to say that banks put on a good show last week, surprising the market with the volume of cash handed back to the ECB, but this was likely a one-off," Icap strategist Chris Clark said.
"The road back to normalisation of euro money markets will be a very long and slow one."
The weekly repayments are gaining increasing market attention, both because of the jump in interbank rates and because they are being seen as a proxy of banks' health and ability to survive without central bank help.
They have another two years to pay back the money and can repay as little or as much as they want each week, but returning the cash is increasingly being seen as a badge of honour to be waved at rivals, rating agencies and shareholders.
Credit Agricole was the latest bank to say it had started repaying its LTRO funding on Friday and its in-house strategists said the small overall weekly number would prompt the market to revert to its original view that the pattern of repayments would be steady rather than sudden.
They expect Eonia rates for one-year and beyond "to gradually rise - hence, normalise towards the refi rate - while the shorter-dated tenors, particularly up to the six-month tenor, should have scope to fall modestly from current levels," they said in a note.
The effect of the liquidity withdrawals has been greatest on longer-dated money market rates because the excess of cash is large and not expected to fall to 'normal' levels for some time.
For Europe's struggling debtor countries and the ECB, the jump in banking market rates is not ideal because it effectively tightens money policy and creates unwanted stress just when the bloc's economies are showing fragile signs of improvement.
The loans, which banks can keep for up to three years, were designed to stop lending freezing up after its sovereign debt crisis spiralled in 2011.
Influential ECB Board member Peter Praet demonstrated the central bank's sensitivity to a too-rapid withdrawal of liquidity earlier this week.
"We will exert vigilance to ensure that ... the overall liquidity conditions prevailing in the money market will remain consistent with the degree of accommodation that the current outlook for prices and real activity warrant," Praet said.
Market analysts will now focus on the ECB's monthly policy meeting next week before switching the bulk of their attention to Feb. 22 when the ECB will announce how much banks want to instantly repay of the second 530 billion LTRO (longer-term refinancing operation).