Interbank rates push higher

Liquidity conditions look set to tighten in coming weeks, creating upward pressure on overnight interbank rates while longer-dated euro borrowing costs extended their recent rise on Tuesday on building inflation concerns. Banks opted to replace 248 billion euros of expiring one-week and 21-day European Central Bank loans with around 247 billion euros of funding at the central bank's regular tender.
The drop in demand was only 0.8 billion euros, but a 14.5 billion euro increase in the ECB's estimate of how much funding banks will need over the next reserve maintenance period means overall liquidity surplus will be low relative to recent levels. This translates to higher overnight rates as banks compete for a lower pool of excess liquidity.
"This would mean the new reserve period will start tomorrow in the context of very strict liquidity conditions," said Barclays Capital strategist Giuseppe Maraffino. A new reserve maintenance period - the timeframe over which banks are required to deposit a set level of funds with the ECB - begins on Wednesday, lasting 21 days.
"Excess liquidity levels are some 15 billion lower and on average over the next week around 24 billion euros, so not very much (Eonia) could perhaps push up perhaps higher than initially expected by markets," said Commerzbank rate strategist Benjamin Schroeder. Three-week Eonia prices covering the maintenance period rose by around 4 basis points to 0.68 percent, extending a 6 bps rise in the previous session.
Barclays Capital forecast the Eonia overnight rate would average around 75 basis points throughout the January reserve period, starting out at around 80-85 bps before declining to 40 bps. Typically rates fall over the course of a reserve period, with banks preferring to frontload their central bank deposits, freeing up more cash later on. But with less excess available this dynamic is likely to be more muted than in recent months.
Benchmark three-month Euro Libor hit its highest since mid-December at 0.94438 percent and the eurozone equivalent Euribor rate rose to 1.012 percent. Further out along the curve, 12-month Euribor hit a 1-1/2 year high of 1.552 percent. Interbank rates began rising last week after ECB President Jean-Claude Trichet was perceived to have sounded hawkish on the prospect of rate rises to curb inflation.