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Money markets euribor rates hit lowest since oct 10 on cash surplus


Euribor lending rates hit their lowest level since October 2010 on Thursday and were likely to fall further after the European Central Bank injected another bout of cash into the financial system to restore confidence in the struggling banking sector. Banks snapped up 530 billion euros at the ECB's second offering of cheap three-year funds on Wednesday. The extra liquidity will not solve the underlying debt problems in the euro zone, especially as banks increasingly hoard the cash, but it should stave off a credit crunch. The abundance of cash is expected to push key measures of interbank financial stress towards levels seen before the ECB began buying Italian and Spanish bonds in August 2011 to cap a surge in funding costs as market worries about peripheral euro zone debt escalated. Three-month Euribor rates fell to 0.967 percent from 0.983 percent, hitting the lowest level since October 2010. Simon Smith, chief economist at FxPro, expected the spread between 3-month Euribor and overnight Eonia rates, a measure of counterparty risk, to fall to about 40 basis points by May from around 62 bps currently. The spread was at 35 bps at the beginning of August."It is more likely that we find a floor to that spread in its convergence with those of other major markets, such as the dollar market," Smith added. The U.S. dollar Libor/OIS spread stood at 41 bps.

But Smith also stressed that the euro zone's underlying problems remained."The first round (of LTRO) was all about removing the tail risks of a full-scale credit crunch in Europe and it was successful in doing that and reducing the fears about bank refinancing needs ... I think there is a lot more uncertainty with regards to where this one is headed," he said. Alessandro Giansanti, senior rate strategist at ING, said the improvement in funding conditions resulting from the ECB's second three-year long-term refinancing operation (LTRO) could take the Euribor/OIS spread to 30 to 40 bps over the next month.

That would be the floor, he added, because investors would still require a premium for lending cash for three months as opposed to overnight. The overnight Eonia rate at 0.37 percent could not fall much further given it was already close to the 0.25 percent rate offered by the ECB deposit facility, he said. REAL ECONOMY The ECB's liquidity boost has helped stabilise the banking sector and eased tension in financial markets but has yet to filter through into the real economy.

Indeed, ECB President Mario Draghi urged banks on Sunday to help strengthen economic growth by lending the money they borrow from the central bank at very low rates to euro zone households and businesses. The euro zone's manufacturing sector contracted for the seventh straight month in February, a business survey showed on Thursday. Many fear the austerity measures aimed at reigning in debt levels could choke growth. Meanwhile, the huge cash boost for euro zone banks was a factor behind economists' decision to reverse their forecasts for interest rate cuts this year. The ECB is now expected to keep rates on hold at 1.0 percent until deep into 2013, a Reuters poll of economists showed on Thursday."I think (the ECB is) in the realms of liquidity versus interest rate cuts," a trader said. "If the ECB cuts by 25 bps, will the banks pass it on? Probably not. So why do it?"Euribor futures are pricing in no rate cut in March and a 50 percent chance of a 25 basis point rate cut in June, Giansanti added. That was little changed from market expectations before the LTRO, he said, because that had been widely priced in already.

Money markets signs of stress emerge behind ecb cash shield


* Cheap ECB loans seen as reliable shield against Greek mess* Rates still falling, but trading becomes more "name specific"* Some small signs of interbank stress show upBy Marius ZahariaLONDON, Feb 16 The hefty amount of cash floating around in the euro banking system is generally offsetting fears that a potential messy Greek default could severely hit lenders across the bloc, but tentative signs of stress in the interbank lending market are emerging. Worries that Greece may not get a second bailout are making banks more reluctant to lend to each other again, with traders saying bank-to-bank lending has turned even more "name specific" in recent days, meaning only the strongest banks were active. Benchmark interbank rates continued to fall, with the European Central Bank's injection of nearly half-a-trillion euros into the banking system last year providing comfort. Banks can also take as much of the extra cheap loans as they want at a similar tender at the end of the month. But some signs of stress can still be spotted.

The Markit iTraxx index of credit default spreads for European senior financials - measuring the cost of insuring against a bank defaulting on its debts - has risen by almost 50 basis points in the past 10 days to above 240 bps. But it was still more than one full point below the highs seen in November before the ECB first announced its three-year funding plans."The chance of a liquidity squeeze has been (lowered) but you cannot fully neglect the chance of default from a bank which has exposure to a peripheral country, not only to Greece," said Benjamin Schroeder, rate strategist at Commerzbank."Interbank risks are obviously increasing. If you think contagion can get out of hand problems in interbank markets could (appear) again."

He also said spreads between forward rate agreements and overnight index swaps (OIS)-- a widely used measure of stress in the interbank lending markets -- could re-widen if Greek tensions increased. Morgan Stanley strategist Elaine Lin said the euro Libor/OIS spread, now at 62 basis points, could expand towards 100 bps in case of a disorderly default, levels last seen in early 2009 after the shock of the Lehman Brothers collapse. Another stress measure that is widely used, the cost of swapping euro interest payments on an underlying asset into dollars as measured by the three-month cross currency basis swaps, widened by 4 bps to minus 79.5 bps.

That is still less than half the levels seen in November and some of the widening presure in cross currency markets may also have been triggered by expectations that the Dutch State Treasury may want to swap some of the around $3 billion worth of its first dollar bond being sold on Thursday into euros. ENHANCED FIREWALL Interbank rates maintained their downward trend. The three-month London Interbank Offered Rate for euros, or Libor , dropped to 0.96821 percent on Thursday versus 0.97821 percent on Wednesday. Equivalent Euribor rates also fell"Contagion will be higher in a blowout scenario," Lin said, adding that markets are still expecting the Greek situation to be dealt with in an orderly fashion."But the fact that the ECB is doing the (three-year lending) and the fact that we are at a juncture of doing another one or even the likelihood of an outright QE (quantitative easing) tends to enhance the firewall."As long as a chaotic default is not the main scenario the impact on money markets should be minimum, because "banks' balance sheets have almost written down the entire Greece holdings and U.S. exposure has wound down to minimum", she said.

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