July 26, 2010 / 12:54 PM / 10 years ago

MONEY MARKETS-No new stress after test, euro rates edge up

 * Money market unaffected by bank stress test results
 * 3-mth euro Libor inches up, spread over OIS steady
 * Uptrend in euro rates seen intact
 By Ian Chua
 LONDON, July 26 (Reuters) - The euro zone interbank funding
market reacted calmly on Monday to Europe's bank stress test
results, and the absence of nasty surprises will see the
European Central Bank continue to withdraw liquidity.
 Such a move from the ECB would keep the upward pressure on
euro money market rates, which grew after banks paid back 442
billion euros of one-year emergency loans to the ECB on July 1,
wiping off a chunk of excess liquidity from the market.
 "The result of the stress test gives comfort to the ECB in
terms of their exit strategy and so the market basically fixes
the Euribor higher, expecting the money market curve to converge
to a fair level at the end of the year," said Alessandro
Tentori, strategist at BNP Paribas.
 This means the overnight Eonia rate EONIA=, set at 0.5
percent on Friday, will creep up towards and even surpass the
ECB's benchmark refinancing rate of 1.0 percent over time. A
move up to 1.0 percent would signify a return to a more normal
functioning market.
 Eonia is a weighted average rate of all overnight unsecured
bank-to-bank lending transactions.
 The three-month euro London interbank offered rate
EUR3MFSR= edged up slightly to a fresh 11-month high of
0.66125 percent on Monday but the spread over the equivalent
overnight index swap rate EUREON3M= -- a closely watched gauge
of money market stress -- held steady at 24 basis points. 
 The ECB will probably draw comfort from the result that
showed only 7 banks out of 91 failed, and continue withdrawing
its extraordinary liquidity support introduced at the height of
the financial crisis following the collapse of Lehman Brothers.
 For more on the stress test, click on [ID:nSGE66P089]
 "The stress tests didn't really impact the interbank markets
to any great extent," said ICAP analyst Chris Clark, adding the
forward markets, having factored in an improvement in money
market stress levels last week, was little changed as well.
 See [ID:nEAP000044] for full Libor fixings.
 While there are concerns the stress tests may be too
lenient, analysts said they offered added transparency to the
sector which could help restore confidence between some banks.
 The wholesale funding market is still closed to some
financial institutions and analysts expect the weakest ones will
continue to rely heavily on ECB support.
 "It's going to take time for people to work through the data
and everyone wants to see 2Q results as well," said James
Chappell, financial sector strategist at Olivetree Securities.
 "(The stress test is) not an instant fix and there still are
issues that need to be dealt with, but it's a step forward."
 One of the issues, market participants say, is Basel III,
the new set of rules laying out how much capital banks need to
set aside against their lending.
 "There is still a big uncertainty about what Basel III will
require in terms of various new ratios like liquidity ratios and
leverage ratios," said Christophe Nijdam, bank analyst at equity
research firm AlphaValue.
 "As long as Basel III worries are not answered, for some of
the euro zone banks, there will be some problems for them in the
interbank market."
 (Editing by Ron Askew)

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