Stress levels high on eurozone

A key measure of financial stress hit its widest level in more than two years on Friday as challenges for the eurozone mounted and with investors expecting little from a Group of Seven financial summit. Euribor futures extended gains on Friday after the European Central Bank on Thursday signalled a stop to its monetary tightening cycle and sounded downbeat on growth. But some in the market said the move could have been overdone.
Measures of counterparty risk remained elevated as G7 finance ministers and central bankers met in Marseille, under pressure to find new solutions to the global slowdown and debt crises on both sides of the Atlantic. Risk aversion rose as sources told Reuters ECB Executive Board member Juergen Stark would quit because of a conflict over the bank's bond-buying programme and as investors waited to see how many banks sign up for a Greek bond swap.
"There are a number of events which are conspiring to ensure that risk appetite diminishes and that is set to continue certainly over the near term," said Richard McGuire, rate strategist at Rabobank. The spread between three-month Euribor rates and three-month Eonia rates - a measure of counterparty risk - was at its widest since early 2009 at around 80 basis points as overnight rates fell after ECB President Jean-Claude Trichet's Thursday comments.
McGuire said the spread could widen further but added it was still a way away from a high of 196 bps in October 2008, after the collapse of Lehman Brothers. Another key indicator of financial stress hit its highest since April 2009. The three-month spread between euro Libor rates and overnight index swap rates was at 73 bps on Friday from 71 bps the day before. The equivalent US three-month dollar LIBOR/OIS spread rose to 25 bps from 23 bps on Thursday - close to its highest in more than a year.
Financial stress in money markets has intensified in recent months on increased worries that a deterioration in the debt crisis will eventually take a toll on European banks, which are heavily exposed to the debt of peripheral countries. Eonia forwards were still pricing in a 25 bps rate cut by year-end.