Euro rates to stay low

Eurozone short-term interest rates looked set to remain low as the central bank's limit-free lending continued to distort money markets, even as banks scaled back borrowing after the year end. At the European Central Bank's weekly offering of seven-day cash on Tuesday, banks took 195.7 billion euros, compared with almost 230 billion the week before.
Analysts and traders said the effective drain in excess liquidity may be an indication of markets normalising but they stressed it merely reversed a strong take-up when banks needed to stock up on cash over the year-end. Key three-month euro-priced bank-to-bank lending (Euribor) rates fell to 0.999 percent on Tuesday, below the ECB's 1.0 percent main rate for the first time since mid-October on Tuesday.
The break above the ECB's rate in October was expected to be a milestone in money markets' return to normality, but interbank rates dropped back as debt problems in the euro zone forced the ECB to extend limit-free lending to banks out to mid-April. Banks in the eurozone have been reluctant to lend to one another, wary about their exposure to shaky sovereign debt, leaving banks in some indebted peripheral countries reliant on the ECB for funding.
"The ECB's decision to extend the full allotment has for sure put downward pressure on Euribor rates and it's a trend you can also see in the Eonia curve," said UniCredit economist Elia Lattuga. The Eonia overnight rate fixed at 0.42 percent on Monday and forward prices from ICAP reflect market expectations it will only have risen to 0.77 percent by June's ECB meeting.
Adding to the drain after Tuesday's tender, Wednesday will see the expiry of a special tender for 13-day funds on December 23. This was designed to smooth the expiry of the ECB's last 12-month loan made a year ago, at which euro zone banks borrowed 20.6 billion euros. Three-month loans are the longest maturity the ECB offers and banks have paid back all the six-month and 12-month loans the ECB injected during the crisis. The central bank is expected to again keep eurozone interest rates on hold at a record low of 1 percent this month. Economists polled by Reuters expect the bank to keep them there until the fourth quarter of 2011.