* Overnight Eonia spikes above ECB refi rate
* Excess cash seen squeezed further as banks repay ECB loans
* Tensions in short-term markets add impetus on ECB to act
By Emelia Sithole-Matarise
LONDON, April 25 Short-term bank-to-bank lending rates rose to a three-month high on Friday after spare cash in the system fell to a 1-1/2-year low, and are likely to stay elevated in coming days as banks repay a big chunk of ECB crisis loans.
The upward nudge in short-term money market rates is reinforcing expectations the European Central Bank will ease monetary policy further to suport the fragile economic recovery.
The euro zone overnight bank-to-bank lending rate settled at 0.29 percent, 4 basis points above the European Central with one-week Eonia hitting its highest since early July 2012 around 0.265 percent.
Excess liquidity - which is the measure of money that banks have beyond what they need for their day-to-day operations - fell below 100 billion euros for the first time since September 2011 on Thursday, putting upward pressure on short-term money market rates.
It looks set to fall further below the current 92.937 billion euros ($128.53 billion) with banks set to repay about 10 billion euros of longterm loans to the ECB next week unless this is offset by higher demand at the ECB's weekly liquidity operations.
The last time liquidity fell so low in September 2011 it nudged the ECB to introduce its Long-Term Refinancing Operation, a series of emergency loans to banks.
Now, it is adding further incentive for the ECB to act on an "unwarranted" tightening of markets, one of the scenarios the central bank has said could prompt fresh policy action.
"The main scenario is for these kind of tensions to continue to rise for tne next couple of trading sessions then to stabilise," said Matteo Regesta, a strategist at Citi.
"If this stabilisation is not realised, we would expect some measures to be taken by the ECB no later than the May meeting to stabilise the market. It's something I wouldn't rule out."
The ECB meets on May 8 and forward Eonia markets are pricing in some expectation that it will act, as Eonia contracts for the rest for the May to December policy meetings remain way below the spot rate.
The ECB is already under pressure to act as a resilient euro fuels concern of disinflation in the euro zone that could torpedo the region's recovery.
Policymakers have also recently ramped up their rhetoric to talk down the euro. ECB President Mario Draghi said on Thursday weaker inflation could prompt broad ECB asset purchases and the bank could also start charging banks for parking cash with it overnight if there was an undue tightening of its policy stance.
"We consider the increase in shorter-dated forwards (resulting from lower liquidity) as an opportunity to position for increasing ECB speculation," Commerzbank strategists said.
"If the money market fails to regulate itself, chances increase that the ECB would step in," they said in a note.
Not all agree that money market tensions would be enough to force the ECB's hand at the Mya meeting, with euro zone April inflation data due on Wednesday seen a key factor.
"The fact that excess liquidity is falling below 100 billion euros is suporting this idea of a more accommmodative ECB... The question whether or not they will act and how will probably depend on the inflation figure we will have at the end of this month," said Cyril Regnat, a strategist at Natixis. (Graphic by Vincent Flasseur)