July 16, 2012 / 7:11 PM / 7 years ago

MONEY MARKETS-ECB rate cut unlikely to send cash to US-JPMorgan

By Chris Reese and Ana Nicolaci da Costa

NEW YORK/LONDON, July 16 (Reuters) - The European Central Bank’s decision to cut the rate it pays banks for depositing money overnight is unlikely to spur much of a flow of cash into U.S. money market funds, according to a strategist at JPMorgan Securities.

The ECB cut its main interest rate on July 5 to a record low of 0.75 percent and reduced the deposit rate it pays banks for parking money with it overnight to zero in an effort to breathe life into the flagging euro zone economy.

However, banks will likely continue to deposit funds in Europe despite the lack of a return, said Alex Roever, short-term fixed income strategist at JPMorgan Securities in New York.

“We expect only a limited amount of this money to work its way into U.S.-dollar based assets in search of a yield advantage,” Roever said.

“Most of the money invested in Euro-based funds isn’t there because of relative value versus other currencies, rather it is there because the shareholders have a need for liquid assets denominated in the euro,” he said.

“We think cash that may leave a euro money market fund is more likely to wind up on deposit at a core European bank than it is to be invested in a U.S. money market fund,” he said.

Euro zone bank-to-bank lending rates hit new all-time lows on Monday in the wake of the ECB move, and could ease further before stabilizing at a premium over overnight rates.

Short-term Euribor rates that banks publish for lending to each other have been driven to an all-time low, which in turn should encourage consumers and companies to borrow more at the lower rates.

But that fall for the moment looks academic given that nervousness over economic and systemic threats are still prompting banks in reality to keep vast quantities of their cash parked at the ECB.

The unprecedented cut in deposit rates to zero means institutions get no return on that cash but not that that has made a difference to the amount of money parked at the ECB - much of it has just been shifted to a current account facility which also offers no interest.

That suggests that, at least initially, no-one in the sector has enough faith in public finances in the euro zone, its banking sector or the health of a reeling economy to risk lending more. Most analysts are skeptical that will change.

“It doesn’t matter what rate it is, the banks aren’t going to lend,” one trader said. “Balance sheets haven’t been restored and what’s going on regarding Libor, more banks are going to get fined, that’s a hit on their balance sheet as well.”

Barclays Plc, the bank at the center of a scandal over the attempted manipulation of London’s Libor system of setting interbank rates, was fined a record $450 million last month by U.S. and British authorities.

It is the only bank so far to admit any wrongdoing in giving false information as part of the complex process of setting Libor, but more than a dozen banks are expected to be drawn into the scandal, which is being probed by authorities in North America, Europe and Japan.

Three-month Euribor rates, traditionally the main gauge of bank-to-bank lending, hit a new all-time low of 0.477 percent on Monday, down from 0.486 percent on Friday.

The trader expected Euribor rates to stabilize around 0.30-0.35 percent, offering a premium over Eonia overnight rates which have also fallen steadily since the ECB rate cut.

Eonia rates were last at 0.12 percent, having fallen sharply after the deposit facility rate — which serves as a floor for bank-to-bank overnight rates — was cut to zero. Forward contracts suggest those rates will only stabilize at around nine basis points.

“Expectations of low Eonia rates have become deeply entrenched. Eonia is now expected to rise above 75 basis points (0.75 percent) only after three years,” Deutsche Bank said in a research note.

Richard McGuire, strategist at Rabobank, also does not expect the reduction in the deposit facility rate to spur bank lending in the current scenario.

“We are still flirting with recession in Europe and in the developed world and hence banks are reticent to lend against such a backdrop,” McGuire said.

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