Money markets eonia rates trend higher as banks grow cautious on funding

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Nov 27 Overnight Eonia lending rates have been creeping higher as banks repay the European Central Bank the long-term funding they borrowed during the height of the debt crisis, prompting excess liquidity to fall. Excess liquidity in the euro zone banking sector - the amount of money in the market over and above what the banking system needs to function - last stood at 154 billion euros. It fell below the 200 billion-euro threshold - where historically Eonia rates have risen - in October. The latest data underscore the tendency among banks to repay long-term funding to the ECB rather than borrow more, analysts said. The ECB lent banks 5.926 billion euros in a 91-day operation, in line with a Reuters poll forecast but short of the 6.823 billion euros maturing that same day from an old operation."The three-year LTRO (long-term refinancing operation) repayment remains high, there is no increased demand in the longer-term operations, even though they do cover year-end, so there seems to be a reluctance to take on a longer ECB funding, or even a tendency to shed longer-term ECB funding," Benjamin Schroeder, strategist at Commerzbank said.

"It definitely highlights the liquidity risks we have when we start in the next year."Eonia rates have crept higher in recent weeks and last traded at 0.13 percent compared with around 0.07 percent in mid-November.

Schroeder said overnight Eonia lending rates may fall back to single digits following month-end, after the ECB lent 97 billion euros in a 7-day operation on Tuesday and failed to fully sterilise its bond purchases by draining liquidity out of the system. But analysts expect rates to trend higher next year. In theory, the fact that banks don't need as much funding is a sign that they are on a stronger footing, though some analysts say there is a growing stigma associated with borrowing more or not repaying loans as quickly as others have done. But in practice, it also tightens monetary conditions - by lowering excess liquidity and putting upward pressure on Eonia rates - at a time when the ECB is trying to boost growth.

ECB officials have hinted at more monetary easing in recent weeks, after the pace of the euro zone recovery slowed more than expected in the third quarter. An unexpected fall in annual inflation for October prompted a surprise ECB rate cut. As excess liquidity continues to drop and Eonia rates to rise, analysts say speculation about more ECB action will mount. The latest such talk involved the possibility of another LTRO. The ECB is considering an operation available only to banks that agree to use the funding to lend to businesses, a German newspaper reported on Wednesday, citing sources."The more general worry is that as excess liquidity declines, it does put some upward pressure on Eonia rates and for that reason, if they were to do anything else, in the first instance it would be looking to take the deposit rate into negative territory," Philip Tyson, strategist at ICAP said.