LONDON: Take-up at the ECB's new three-year tender should be reasonable and could be high, with money market funding tensions likely to increase if Standard & Poor's goes ahead with a threatened downgrade of most euro zone countries.
The European Central Bank will next week offer banks the longer-term funds with the option of repayment after 12 months in attempt to ease the credit squeeze that has resulted from the euro zone debt crisis.
Analysts have yet to state their predictions for take-up at the tender, which will be held on Dec. 21, but a Reuter’s poll of money market traders puts demand at 100 billion euros, although forecasts from the 18 polled ranged from 20 billion euros to 250 billion.
"There will probably be a lot of demand but the question is whether it is new money or shifting out of existing operations," said Commerzbank rate strategist Christoph Rieger.
Banks face a 700 billion euro wall of funding redemptions next year, according to the European Banking Association, most in the first half, which is likely to underpin demand for the longer-term cash while clarity over the ECB's liquidity provision plans should clear the way for banks to allocate collateral to the operations.
"The array of liquidity measures by the ECB should avert any bank funding accidents for the time being," BNP Paribas credit strategists said, but they added that the central bank's decision not to expand its sovereign debt purchase programme meant sovereign funding was still riddled with uncertainty.
Banks are already awash with liquidity, with 335 billion euros of spare cash parked at the ECB overnight but the dysfunctional money market was reflected by one or more other banks borrowing over 7 billion euros at penalising rates from the ECB's overnight lending facility.
The protracted use of the facility throughout the third quarter has raised concerns over whether banks have enough collateral to access the ECB's liquidity providing tenders, and the amounts borrowed from it have risen in December.
However, RBS rate strategist Simon Peck said he expected the amounts taken to fall somewhat after year-end.
"It's unsurprising that we get elevated usage of this facility in this environment, especially as December is a month when funding pressures come to the forefront ahead of year end."
The ECB has halved the reserve requirement and widened the collateral base in further moves to free up funding.
More collateral available to use at liquidity operations could also contribute to a fall in the use of the emergency lending facility while a large take-up of three-year funds may ease some nerves about lending in the interbank market.
"A large take-up... would in fact be a positive event and a catalyst in stimulating European bank funding markets by exerting downward pressure on bank funding costs," said Nikolaos Panigirtzoglou, European head of global asset allocation and alternative investments at JPMorgan.
The next test for financing markets will come if Standard & Poor's carries out its threat to downgrade 15 euro zone countries, including France and Germany.
Sovereign bonds are used in the repo market by banks to raise short-term funding, with the trade often arranged by a central clearing house.
These so called "tri-party" repo trades are based firstly on the bonds' credit rating, then the type of bond for example sovereign and finally by issuer.
JP Morgan calculates that the European market is worth 340 billion euros, with around half of that based on triple-A rated collateral, including 70 billion euros for Germany and 30 billion euros for France.
"If only France is downgraded, the main beneficiaries are likely to be Bunds and UK Gilts," said Panigirtzoglou.
However, he said that if all triple-A euro area countries were downgraded, Gilts would benefit initially but there would likely be a relaxation of rating restrictions in tri-party agreements to double-A.
"Somewhat counter-intuitively, this second scenario is probably less damaging for the French repo market than if only France is downgraded."
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