July 6, 2010 / 3:18 PM / 9 years ago

MONEY MARKETS-Cash drain points to rising Euribor

 * Pace of liquidity drain could halve excess cash in July
 * Euro Libor, Euribor hit 10-month highs
 * But no change to ECB rate expectations
 By George Matlock
 LONDON, July 6 (Reuters) - A 72 billion euro liquidity drain
from the European monetary system fuelled expectations of higher
interbank borrowing costs to come as bank-to-bank rates scaled
10-month highs on Tuesday.
 The London Interbank Offered Rate (Libor) in three-month
euro funds EUR3MFSR= hit 0.74 percent at the London fixing,
its highest level since Sept 9. Euro Libor has been creeping up
since hitting a euro lifetime low of 0.57563 percent on April 1.
[ID:nEAP000024]
 Similarly, the three-month Euribor bank-to-bank rate in
Frankfurt earlier on Tuesday fixed at a 10-month high of 0.797
percent. [ID:nEAP000472]
 The European Central Bank lent a combined 274.15 billion
euros last week in six- and seven-day funds that expire on
Wednesday.
 But ahead of that expiry, the ECB lent only 229.07 billion
euros earlier on Tuesday and means a 45 billion euros net drain
in liquidity. [ID:nECB000074]
 In addition, the ECB drained -- as targeted -- 59 billion
euros in a one-week deposit tender on Tuesday to neutralise the
effects of its government bond purchases, which also made good
on a 27 billion euros shortfall in last week's sterilisation
attempt. [ID:nLDE665154] [ID:nFAE005727]
 The total reduction of ECB liquidity on last week is 72.2
billion euros and contributes to the current final week of the
June maintenance period for bank reserves.
 "If the trend in the weekly Main Refinancing Operations is
sustained, the level of ECB excess liquidity provision over
banks' structural funding needs would halve in July compared to
250 billion currently," said Lena Komileva, head of G7 market
economics at Tullett Prebon in London.
 It would also mean Eonia rates staying elevated and lift
Euribor further, she said.
 The overnight EONIA rate EONIA= fixed at 0.405 percent on
Monday. 
 "The fact the ECB's one-week deposit tender today produced
marginal/average rates of 0.75/0.56 percent respectively,
compared with Euribor at 0.459 percent suggests higher rates in
short-term maturities related to the ECB's exit strategy will
continue to pull 3-month Euribor higher," Komileva said.
 
 NO CHANGE TO RATE EXPECTATIONS
 But the higher Euribor and euro Libor rates are unlikely to
bring forward the first ECB policy rate hike.
"The liquidity reduction was better than the market was
expecting, and futures sold off as a result. A reduction of
liquidity is part of the ECB's exit strategy, so I simply see
this as a marker of progress rather than bringing forward a rate
hike," said Peter Chatwell, market strategist at Credit Agricole
in London.
 The ECB next meets to determine interest rates on Thursday.
A Reuters survey of economists indicates rates are likely to
remain at 1.0 percent until the third quarter of 2011.
[ID:nRPO5p5W3]
 The fact that liquidity has been reduced also does not
indicate ebbing stress in the banking sector.
 "A significant amount of the one-year 442 billion euros
which expired on July 1 was from strong banks playing the
arbitrage. It's not at all clear that banking stress is easing,"
said Chatwell.

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