July 13, 2012 / 1:56 PM / 7 years ago

MONEY MARKETS-Euro money markets test uncharted waters

* Money markets tackle unchartered waters

* Search for yield as more rates turn negative

* Spain, Italy benefit

By Kirsten Donovan

LONDON, July 13 (Reuters) - The implementation of the European Central Bank’s zero percent deposit rate this week has pushed money markets into uncharted territory, forcing many to accept negative returns while seemingly doing little to spur bank lending.

T-bill yields and repo rates are below zero for the euro zone’s more-trusted “core” countries and they are falling even for Spain and Italy - despite the euro zone debt crisis appearing no closer to being resolved. Bank-to-bank Euribor lending rates are in freefall.

The ECB last week cut its main refinancing rate to 0.75 percent and its overnight deposit rate - which is paid to banks that park cash in the central bank’s deposit account - to zero.

The changes came into force with the start of the new maintenance period on Wednesday but JPMorgan Chase & Co, BlackRock Inc, which is the world’s largest money manager, and Goldman Sachs Group Inc had already restricted investor access to European money market funds .

Commerzbank strategist Christoph Rieger described the move to zero or negative rates as “a small step for the ECB but a giant leap for money markets”.

“While some investors will likely still be willing to pay a price for safe investments, others will either be keen to exit the euro or should grudgingly revise their credit and duration limits... in an attempt to preserve the nominal value of their investments,” he said in a note.

While banks are now not making any cash from the ECB, analysts are sceptical that they will increase lending to the wider economy in response. But there is some suggestion that banks may be seeking even modest returns by buying more sovereign debt - which could potentially ease euro zone policymakers’ headaches somewhat on that front.

Tradeweb quotes one-month T-bill yields for Germany, France, Holland and Belgium at close to zero or below, while Spanish yields have fallen to 0.90 percent from around 1.5 percent ahead of the ECB meeting.

Similarly, secured lending rates in the repo market - where banks commonly use government bonds as collateral to raise funding - have collapsed.

General collateral repo rates, which are paid to borrow funds against a basket of government bonds, are negative for the core countries and falling in Spain and particularly Italy. An Italian bond auction on Friday saw good demand despite a ratings cut earlier in the day.

“Italy appears to have been a major beneficiary of the search for yield,” said ICAP economist Don Smith, referring to the repo market.

“Bid interest in this market has surged in the last two days and repo rates have correspondingly dropped...(jibing) with the previous rising trend set against a backdrop of elevated lending concerns.”


With no incentive for banks to deposit money at the ECB overnight, cash is being hoarded in institutions’ current accounts, central bank data showed this week.

While it is impossible to tell how much money may be being used to buy shorter-dated government bonds from the figures, there is only anecdotal evidence from market players.

However, Smith says reports from Brokertec’s euro government bond platform suggest a “scramble” for short-dated Austrian, Belgian, French and Dutch debt.

But without cash filtering through to the broader economy, the ECB may be pressed into cutting interest rates further, adding to the pressure on yields.

Klaas Knot, one of the central bank’s Governing Council members on Thursday signalled ECB policymakers could act again, holding out the possibility that the deposit rate could be cut below zero - something the Danish central bank did last week .

“Because the amount of cash at the ECB hasn’t really reduced, the market is left to speculate that sentiment hasn’t changed and maybe the ECB should do something about it. That’s what the market is weighing up for the moment,” said Credit Agricole rate strategist Peter Chatwell.

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