Interbank tension surfaces as global worries weigh

* Bank borrowing from ECB increases, average maturity up
* Widening gap between overnight and 3-month rates
* Swap rates tumble as longer-dated bonds markets rally

William James
Reuters

Banks increased borrowing from the European Central Bank on Wednesday and sought longer loans, in an early sign that worries over the health of the economy were spilling into money markets.

At the ECB’s refinancing operations euro zone banks took less one-week money and more three-month loans, leading to a net increase in overall ECB lending of around 2 billion euros.

Safe-haven assets and less risky currencies have rallied strongly this week at the expense of equities due to the bleak U.S. outlook, which threatens to undermine recovery in the euro
zone.

“Things were going a bit better, but when the stock exchanges went down, you immediately saw the effect of that in the money markets,” a money market trader said.

“Banks will not lend to each other in longer terms and this will keep a difficult situation going for even longer.”

This tension was demonstrated in the short-term markets both by banks’ increased reliance on ECB loans and a widening gap between overnight and longer-dated money market rates.

Overnight rates — expected to rise as banks are weaned off ECB support — have trended down over the last two maintenance periods because the level of ECB loans in the system has remained relatively constant. On Tuesday, Eonia EONIA= fixed at 0.41 percent and was seen falling further below 40 bps.

Meanwhile, the benchmark three-month interbank Euribor and euro Libor rates have plateaued and show little sign of decreasing, suggesting a renewed reluctance to lend between banks over longer terms.

Three-month euro Libor EUR3MFSR= fixed slightly higher at 0.82875 percent, while equivalent Euribor EURIBOR3MD= rose slightly to 0.89 percent. The spread between three-month Euribor and Eonia has widened by 17.5 bps since mid July.

With risk appetite suffering globally, pressure appears to have resumed on the euro zone’s higher-yielding states, adding to interbank tension.

“I would see this against a background of renewed, increased tension in peripheral sovereign bond markets,” said Klaus Baader, chief European economist at Societe Generale.

“Generally when risk aversion increases funding conditions become tighter, in particular for banks in those countries which are seen as fiscally vulnerable.”

Ireland’s credit rating was cut late on Tuesday with rating agency Standard and Poors citing the cost of supporting the ailing Irish financial sector.

SWAP RATES TUMBLE

The tension in markets over the global outlook was also seen in interest rate swaps where the 10-year euro swap rate sank to a new record low and 30-year swaps again fell.

The drive for a return on low-risk assets has seen bond curves flatten. This in turn is driving swap rates lower.

“For a good steepening you probably need a reversal of the initial impetus… you need stronger data basically and for a reassessment where markets bring forward their policy rate expectations instead of pushing them back,” said Robert Crossley rate strategist at Citigroup.