Money markets early ltro payback poses no threat to low rates

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* ECB loan repayment to add little upward pressure to Eonia* Cash surplus high enough to dull impact of any paybacks* Repayments may signal strength, drive lending rates lowerBy William JamesLONDON, April 3 Euro zone money market rates are likely to stay pinned at rock-bottom levels for years by the weight of cheap ECB cash in the system, even if banks choose to repay the central bank loans early. The European Central Bank pumped a trillion euros of three-year loans into euro zone financial institutions in two Long-Term Refinancing Operations (LTRO) in response to growing fears that banks would struggle to refinance their debt against the backdrop of the sovereign crisis. In addition to driving Italian and Spanish bond yields lower, as banks used the funds to buy sovereign debt, the huge surplus of cash has flooded money markets, cutting overnight Eonia rates in half and the benchmark Euribor lending cost to a 21-month low.

Against this more positive backdrop some banks have been able to raise long-term funds in the capital market to pay down their debt, and could opt to show strength by repaying the ECB cash early and funding themselves through the open market."We estimate around 110 billion was borrowed for refinancing. If the capital markets are open for banks they might not replace their maturing bonds with ECB borrowing and that money will be eventually returned," said Nikolaos Panigirtzoglou, strategist at JPMorgan in London. But, given the enormous 777 billion euro excess of cash in the system, even if some banks choose to repay the loans at the first available opportunity early next year, rates are likely to remain at or below their current artificially suppressed levels."Even if perhaps 100 billion is being repaid I don't think that is going to have a major impact on the short end of the curve," said Elwin de Groot, market economist at Rabobank.

"There's so much excess liquidity Eonia rates will stay close to where they are almost whatever happens."Eonia fixed at 0.347 percent on Monday, and one-year equivalent rates were less than 2 bps higher, indicating few in the market expected a liquidity withdrawal substantial enough to squeeze money supply and push rates up. JPMorgan's Panigirtzoglou said that even a repayment of 300 billion euros would probably only lift the Eonia fixing by 5 to 10 basis points.

Longer-term interbank rates could actually fall further if banks choose to repay early, signalling a sooner-than-anticipated revival in confidence, analysts said."If this is viewed as a positive signal, it means that confidence is returning and banks will look to increase the maturities (of lending) in the interbank market - and that will lead to a fall in risk premiums," Rabobank's de Groot said."To some extent that is exactly what the LTRO was aiming for."However, with the risks of a flare-up in the euro zone crisis far from extinguished, analysts said it was too soon for banks to commit to early repayment, as they may need to invest the cash in sovereign bonds to keep their governments afloat."There is still a lot of buying to be done by Spanish and Italian banks if they are willing to support their sovereign. A lot can happen between now and next February - they might need to buy even more than we currently think," Panigirtzoglou said.