Bank woes push up Euribor rates and demand for ECB funds

FRANKFURT: Key euro-priced bank-to-bank lending rates and demand for ECB funding rose on Tuesday as growing concerns about European banks' ability to handle the euro zone's sovereign debt crisis outweighed an incoming wave of central bank liquidity support.

In response to intensifying euro zone troubles, the European Central Bank last week reinstated some of its most potent crisis-fighting tools, including 1-year liquidity injections.

The moves are expected to keep euro money market heavily oversupplied with liquidity for the foreseeable future and thereby maintain downward pressure on interbank lending rates.

Banking sector tensions continued to outweigh the prospect of new ECB support on Tuesday, however.

Three-month Euribor rates , traditionally the main gauge of unsecured interbank euro lending and a mix of interest rate expectations and banks' appetite for lending, rose to 1.570 percent from 1.567 percent.

Money markets are already well overstocked with ECB funding. Excess market liquidity topped 210 billion euros on Tuesday, according to Reuters calculations, the highest level since the end of June last year.

At the same time, and underscoring the nervousness that has paralysed the interbank market, banks also parked 270 billion euros at the ECB.

Six-month Euribor rates also rose, climbing to 1.771 percent from 1.768 percent, while 12-month rates increased to 2.106 percent from 2.102 percent.

Shorter-term one-week rates , normally the most heavily influenced by excess liquidity, defied the downward pull of the current cash overhang, rising to 1.191 percent from 1.185 percent.

Overnight rates bucked the trend, fixing at 0.092 from 0.919 percent the previous day.

Banking sector and sovereign debt worries continue to weigh heavily on the euro zone. Europe's banks are expecting to be told to raise more capital in the wake of state rescue of Franco-Belgian lender Dexia SA earlier this week.

Uncertainty created by the debt crisis engulfing much of southern Europe has increased banks' reluctance to lend to each other and prompted many banks to stock up on ECB euro funding.

At the ECB's latest offering of weekly loans, a combined 166 banks took 205 billion euros, up from just under 200 billion the same amount took last week. 59 billion euros was also taken in a separate handout of 1-month loans, up from 54 billion last month.

The deepening crisis has forced the ECB back into emergency mode. It is set to reintroduce ultra-long 1-year funding, plus one of 13-months and has also extended limit-free funding in all its lending operations until the middle of next year.

The central bank is also buying sovereign bonds again, including the debt of Italy and Spain. The next update on its purchases is due on Monday at 1330 GMT.

Copyright Reuters, 2011