LONDON: The euro zone's key overnight lending rate is set to fall in coming days after banks increased demand for European Central Bank funds on Tuesday, lifting the cash surplus in the financial system.
Overnight Eonia fixed at its highest in three years at 1.43 percent on Thursday as banks scrambled to meet their reserve needs with the ECB before the Easter break and as excess liquidity in the euro system dwindled to nine billion euros from around 20 billion, according to Reuters calculations.
But with banks having bid for 118 billion euros at the ECB's weekly tender compared with 97 billion euros last week, boosting excess liquidity by around 20 billion euros, the upward trend in Eonia was expected to start reversing on Tuesday.
"I expect Eonia to decline from its peak but suspect it will not decline much below 1 percent," said Patrick Jacq, a rate strategist at BNP Paribas.
"We see that excess liquidity is gradually decreasing so you have more banks which have to go to the market and we see that with the rate hike cycle some investors are reluctant to supply the market with liquidity," he said.
The ECB's tender of three-month funds could further boost excess liquidity if market participants remained concerned about the continued pressure on EONIA fixings for the rest of the reserve maintenance period ending May 10, some analysts said.
The central bank is expected to allot 75 billion euros at the longterm refinancing operation, according to a Reuters poll of money market traders.
There was no sign for now of contagion spreading to money markets from euro zone sovereign debt markets where persisting speculation about a Greek debt restructuring have driven Greek, Portuguese and Irish bond yields to euro-era highs, analysts said.
UPWARD TREND INTACT
Tuesday's increased bank take-up of seven-day funds and a stable reserve requirement balance was likely to keep the liquidity surplus at a more comfortable 30 billion euros -- excluding Wednesday's three-month refinancing operation -- in the coming week, some analysts said.
"This should give some relief to the high EONIA fixings in the last couple of days, but it will still likely be exposed to some upside, given the continued holiday season in the UK," Morgan Stanley strategist Elaine Lin said.
Financial markets are shut in Britain on Friday for the wedding of Prince William and Kate Middleton.
Besides dwindling liquidity, short-term money market rates have climbed to their highest levels in two years and are set to climb higher as traders bet the ECB will raise official borrowing costs again in July after a rate hike earlier this month ended almost two years of record-low interest rates.
London interbank offered rates fixed up at 1.32125 percent versus 1.31750 percent on Thursday while the equivalent Euribor rate fixed at rose to 1.361 percent, the highest since late April 2009, from 1.356 percent the previous day.
Attention is also focusing on what the ECB will do with its unlimited liquidity policy in the coming months aimed at helping smaller euro zone banks shut out of the interbank market.
In March it left all its operations at full allotment until July, putting its exit strategy on hold for the second quarter running. But recent comments from Ewald Nowotny and Axel Weber have increased expectations that the bank will soon restart the phasing out process.
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