The Eonia overnight rate is set to hit its highest level since February this week as the European Central Bank's new maintenance period starts with higher interest rates. The ECB has raised its main refinancing rate to 1.25 percent, ending almost two years of record low interest rates, and money market rates have risen as the market prices in expectations of more tightening to come.
The Eonia overnight rate, which has historically traded just above the ECB's refinancing rate, has been compressed by the ECB's provision of unlimited liquidity, which will continue to cap its rise. The rate began the March maintenance period at 0.84 percent before falling to 0.54 percent - a typical pattern as banks tend to front-load their reserve requirements in the early part of the period - to give an average rate of 0.67 percent.
"Reflecting the hike in the refi rate, we expect Eonia to trade higher, but remain below the refi rate because it is driven by the excess liquidity," said Barclays Capital rate strategist Giuseppe Maraffino. With excess liquidity currently at its lowest levels since June 2009 at around 10 billion euros, according to Reuters calculations, how much funding banks take at this week's open market operations will be key.
This week 84.5 billion euros of one-week money expires, along with 82.3 billion euros of one-month funds and with tenders being held on Tuesday. "If demand for ECB liquidity is good we could start the new maintenance period with an excess of 30 or 35 billion euros, but if it is low then we could see sharp tension on Eonia in the first part of the period and volatility throughout," Maraffino said.
In the first case, Eonia will fix around 1.05 percent, he said, rising to 1.10 or 1.15 percent in the latter, in either case the highest levels since early February. Excess liquidity in the money market is currently around 10 billion euros, according to Reuters calculations, the lowest level since June 2009, just before the ECB offered banks access to unlimited one-year funding for the first time. With the ECB signalling it could raise rates further, benchmark three-month euro Libor rates have continued to rise, fixing at 1.255 percent on Monday.