Money markets ecb loan repayments to weigh on short dated rates

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Feb 20 The repayment of European Central Bank crisis loans could weigh on short-dated money market rates as long as excess liquidity remains above the 200 billion euros level that usually keeps a lid on rates. Banks have so far paid back around a third of the almost 500 billion euros in three-year loans they took from the European Central Bank in late 2011 and next week they can start repaying the other half trillion in loans they took in February 2012. The larger than expected initial repayment amount briefly led to expectations that the excess liquidity in the banking system - currently at just over 500 billion - would shrink faster than previously thought, causing a rise in money market rates, especially in those beyond the one-year maturity. ECB President Mario Draghi has cooled those expectations by saying he did not expect the repayments to cause a drop in excess liquidity below 200 billion and that he will monitor money markets to ensure monetary policy remains accommodative.

This week's developments in overnight interbank lending are strengthening the view that money market rates should remain low in the near term, analysts said. The overnight Eonia rate settled at a record low of 0.058 percent on Monday in the day that coincided with the highest volume of overnight rates for this year - 24.2 billion euros. The average daily volume in 2013 was 17.6 billion euros.

"The key argument here is that higher volumes would lead to lower fixings. It could be a manifestation of core banks paying back funding from the ECB and becoming more active in the market as a result," RBS rate strategist Simon Peck said. Peck said Eonia fixings could fall further in the near term, but not significantly.

"What would drive Eonia fixings materially lower is any expectations of a deposit rate cut (from the current level of zero percent), which if you see a worsening in the (euro zone) outlook could become a relevant discussion again," he said. For now, such expectations are contained by a recent improvement in business sentiment across the euro zone, especially in Germany. Commerzbank rate strategist Christoph Rieger said an increase in volumes to 31.3 billion euros, the highest seen since the ECB cut the deposit rate to zero in July, would lead to a 1.5 basis points decline in Eonia fixings. He said the relationship between volumes and Eonia fixings, as well as the view that the excess liquidity would remain ample, warranted receiving positions in Eonia forward rates with maturities until September - effectively a bet that those rates will remain subdued.