* Market stress eases, benchmark Libor rates steady
* One-year euro Libor hits highest since September
* Banks seen struggling to get term funding
By Ian Chua
LONDON, June 18 (Reuters) - Financial market stress eased on Friday with a closely watched gauge falling to a one-month low as worries about Europe’s sovereign debt crisis diminished following a successful Spanish bond sale earlier in the week.
Hoping to restore market confidence, European leaders agreed on Thursday to publish details of “stress tests” showing the financial health of individual banks next month and to toughen budget rules.
“It could turn out to be a key stepping stone towards increasing the transparency of the euro zone banking sector,” said Credit Agricole analysts in a note.
A Spanish government source told Reuters Spain’s largest bank, Santander (SAN.MC), had the best rating so far in the tests.
The two-year dollar swap spread USD2YTS=RRUSD2YTS=TWEB -- a gauge of financial system stress -- fell to 34.5 basis points, well off a one-year peak of 64 basis points set some three weeks ago.
Benchmark interbank lending rates were also steady, according to the latest daily fixings from the British Bankers’ Association. See [ID:nEAP000037]
The three-month euro London interbank offered rate was unchanged at a 5-1/2 month high of 0.66125 percent. Longer-term euro rates, however, rose with the one-year Libor EUR1YFSR= reaching 1.26125 percent, a level last seen in September.
Analysts said only the best banks can get term funding in the interbank money market, which remained shut to smaller banks, forcing them to rely heavily on the European Central Bank for longer-term cash.
With the ECB no longer offering one-year and six-month loans, an increasing number of banks are finding it hard to secure term funding in the unsecured and secured money market.
“The problem for banks is not short-term funding. There is a growing number of banks which are struggling to fund their balance sheets in the one- to two-year horizon,” said Patrick Jacq, strategist at BNP Paribas in Paris.
Spanish banks, in particular, were hit by worries the country may have to seek aid from the European Union and Spain’s treasury secretary acknowledged this week some banks were unable to borrow from foreign financial firms. [ID:nLDE65D1MD]
Spanish repo spreads in the domestic market jumped to nearly 60 basis points versus the one-month EONIA rate from around zero bps in a matter of days this month, Commerzbank said, citing Bank of Spain data, indicating a clear escalation of tension in the secured funding market.
While the repo spreads have since fallen back towards zero, Commerzbank warned the latest drop did not necessarily point to an easing of conditions, saying the data provided only gave the daily average interest rate of realised trades.
In an effort to allay fears Spain will suffer a Greek-style debt crisis, the European Union and International Monetary Fund this week denied a report that said they and the U.S. Treasury were drawing up a safety net for Madrid.
Recent sales of Spanish Treasury bills and bonds met with solid demand, further soothing market nerves, athough Madrid had to offer high yields to attract buyers.
Generally, funding conditions looked set to tighten further, with banks set to pay back 442 billion euros of one-year loans to the ECB on July 1, a move that will drain excess liquidity from the market.
“The upside pressure on Euribors is therefore at risk of intensifying, although spikes like before Lehman are very unlikely during times of full allotment,” Commerzbank analysts said, referring to the fact the ECB will still offer unlimited funds in shorter tenors over the next few months.