December 7, 2011 / 5:56 PM / 7 years ago

Dollar demand in ECB tender shows funding stress

NEW YORK/LONDON (Reuters) - A larger-than-expected take-up of dollars at a European Central Bank tender on Wednesday reflected euro zone banks’ funding stresses but the fact banks were using the facility was seen as a positive.

Banks took more than $50 billion at a three-month operation, which was the first since the world’s major central banks cut the cost of using dollar swap lines with the Federal Reserve last week to help institutions struggling with the fallout from the euro zone debt crisis.

That was well above the $10 billion median forecast in a Reuters poll of money market traders. Banks also took $1.6 billion in one-week funds.

But analysts said there was no reason to panic as dollar-funding stresses were widely acknowledged already.

“We view this as a positive first step — it leads a string of potential policy actions as authorities attempt to break the negative feedback loop from the euro zone and limit contagion back to the U.S.,” said George Goncalves, head of U.S. interest rates strategy at Nomura Securities International in New York.

Morgan Stanley estimated the take-up in the ECB tender was the most since December 2008, with banks able to borrow dollars for three months at 0.58 percent compared with around 1.45 percent before the coordinated central bank action to lower the cost.

Morgan Stanley said some of the demand was probably due to year-end funding needs or reflected somewhat higher funding stress than previously thought.

“The silver lining is that central banks have proven to be willing to backstop funding stresses in the market,” said Elaine Lin, Morgan Stanley strategist in London.

“The coordinated action has encouraged usage which should ensure a smoother year-end, and further narrow the FX basis, given that the market has shown it is willing to take dollars from the ECB instead.”

The tender did little to lower the costs of interbank lending, with the three-month dollar London Interbank Offered Rates (Libor) fixing on Wednesday at 0.54 percent, up from 0.53775 percent on Tuesday and the highest since July 2009.

Goncalves said the interbank lending rates did not dip because there was little direct impact from the tender.

“Even the current three-month Libor set is lower than the interest rate on secured funding through the swap line though Libor is unsecured. At best, the swap line slows the rise in Libor and sets a ceiling in the 70 to 80 basis point region.”

The cheaper dollar tender is just one measure to make funding easier for banks, with the ECB likely to cut interest rates — something that is fully priced by markets — and offer ultra-long euro liquidity at its meeting on Thursday.

“The ECB will try hard to put liquidity to work this week,” RBS strategists said. “There are so many ideas around that there will be some disappointment. But the existence of so many ways to make a difference also guards against failure.”

ECB President Mario Draghi hinted in comments to the European Parliament last week that the ECB could take stronger action to fight the crisis if European leaders agreed on tighter budget controls. Plans for mandatory penalties for countries that exceed deficit targets will be put to a European Union summit on Friday.

While the European debt crisis rolls on, the appetite for shorter-dated, lower-risk securities continues. Fannie Mae FNMA.OB, the largest U.S. home funding source, said on Wednesday it sold $2 billion of benchmark bills at lower interest rates from last week’s sales of similar amounts and maturities.

Fannie Mae sold $1 billion of three-month bills, due March 7, 2012 at a 0.009 percent stop-out rate, or lowest accepted rate, down from a 0.021 percent rate for its sale of $1 billion of three-month bills on November 30.

Editing by James Dalgleish

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