A fresh injection of ECB funding on Wednesday brought a halt to one of the sharpest rises in euro bank-to-bank lending rates in recent history - though perhaps only temporarily. The ECB stunned the markets last week when it said it may well hike interest rates next month, and interbank rates have subsequently risen at their fastest rate since the financial crisis first began to bubble in June 2008.
Wrong-footed traders have been forced to rethink when and how fast Jean-Claude Trichet and his colleagues will increase rates. Before last week's ECB meeting most only expected one or at the extreme two rate hikes this year. Now the consensus view is for three. The three-month euro Libor rate remained static at 1.12938 percent while the equivalent Euribor rate, traditionally the main gauge of unsecured interbank euro lending, dipped to 1.179 percent.
The ECB's decision to keep lending banks all the money they want for at least another three months - supporting those in peripheral countries that are having trouble accessing funding - also works against the natural upward pull of rate hike expectations.
Overall, excess liquidity has dropped sharply since the start of February as banks have tightened their intake of ECB funds by around 100 billion euros. The central bank's decision to keep its cash taps open effectively caps the Eonia overnight rate below official rates, while any build-up of excess liquidity acts like a lead weight dragging them down towards to ECB's 0.25 percent overnight deposit rate. Before the financial crisis, Eonia mostly traded above the central bank's official rate.
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