Euro lending rates up

Key euro interbank lending rates rose on Friday, the day after the European Central Bank hiked interest rates to 1.5 percent but analysts cautioned the market may be being a little complacent in pricing in further tightening this year. The ECB raised interest rates for the second time in four months on Thursday and signalled a further hike is likely this year to tackle inflation despite the intensifying eurozone debt crisis.
Several analysts expect a further hike to come in October but markets - based on forward overnight indexed swap rates - are only just pricing in a further hike around the end of the year. "It's hard to say (ECB President) Trichet was avowedly hawkish but the intention was very definitely to keep the door open for more hikes," said Societe Generale economist James Nixon.
Markets are close to pricing in another 25 bps rate hike by the end of the year, with a second hike by the end of 2012, according to BNP Paribas. But Nomura strategist Sean Maloney said markets were right to be cautious. "Trichet has left October on the table but it is not a done deal," he said.
Benchmark three-month euro Libor rates rose just over half a basis point to 1.53250 percent. Eonia overnight rates have dropped to just under 0.60 percent, driven down by excess liquidity running into the end of the ECB's reserve maintenance period and are likely to average around 1.10 percent over the period, Commerzbank said. But with policy rates set to rise, fixings at such levels are unlikely to be seen again, possible for a number of years, the bank said.
Forwards also looked too low, the bank said with the three-month Eonia rate in three months time at around 1.49 percent around the level of the new ECB's new refinancing rate. Money markets have shown few signs of stress as the eurozone debt crisis has intensified in recent weeks. The ECB's unlimited liquidity offerings have kept rates pinned down despite some banks being reluctant to lend to each other on concerns over the effect of a Greek debt default.
What stickiness there has been has been in the US dollar market where some US money market funds have stopped buying commercial paper issued by European Banks. That pushed the one-year euro/dollar currency basis swap spread, which expands when banks become less willing to supply dollars to each other to as much as 34 basis points in mid-June, compared with 22 basis points earlier in the month. The spread was last at 29.5 bps.