Euribor Futures Drop After ECB Refinancing Auction

Futures contracts on the euro interbank offered rate, or Euribor, fell after banks demanded less cash from the European Central Bank than some analysts anticipated, suggesting the cost of borrowing may rise.

The ECB said it lent 104 billion euros ($141 billion) for three months as some 225 billion euros of long-term loans mature. That compares with 131.9 billion euros at the previous longer-term refinancing operation, or LTRO, of similar-maturity loans on June 30. The lower-than-expected allotment may reduce the amount of excess liquidity in euro money markets, and may lead to higher borrowing costs between banks.

Financial institutions have been wary of lending to each other after Europe’s sovereign-debt crisis fueled concern that some governments may struggle to refinance their debts. The ECB is still lending banks as much cash as they need, although the durations of the loans are shortening. Signs that banks are becoming less reliant on ECB funding may suggest that interbank interest rates may rise toward the ECB’s main refinancing rate, currently a record low 1 percent.

“This is a sign that banks are becoming less dependent on ECB funding,” said Benjamin Schroeder, a fixed-income strategist at Commerzbank AG in Frankfurt. “The market will speculate that Euribor yields will rise faster than before. The probability that rates will rise has increased.” This suggests “some normalization in money markets,” he said.

Expiry Tomorrow

The Euribor contract expiring in March 2011 fell 0.03 to 98.88 as of 1:44 p.m. in London, pushing the implied yield up 3 basis points to 1.12 percent.

Banks tomorrow need to repay 75 billion euros in 12-month funds, 18 billion euros in six-month funds and 132 billion euros in three-month loans. The 12- and six-month loans won’t be renewed as the ECB phases out the non-standard measures used to fight the financial crisis. Today’s three-month loan and a six-day tender tomorrow are designed to help banks through the transition period.

The ECB allotment is “noticeably below expectations and not even matching the expiry of the existing three-month LTRO,” Christoph Rieger, head of fixed-income strategy at Commerzbank, said in an e-mailed note. The lower volume “should add to the upside” in short-dated interest rates, he said.

‘Excess Liquidity’

“Considering that a total of 225 billion euros in three-month, six-month and 1-year LTROs will expire tomorrow and accounting for the net inflow of 13 billion in yesterday’s MRO, today’s allotment gives us a net drain of some 108 billion euros so far,” Rieger said. “This would erase just about all of the excess liquidity in the system.”

The ECB allotted 166.4 billion euros in seven-day funds at a fixed rate of 1 percent at its weekly refinancing operation yesterday. That compared with 153.8 billion euros at the previous auction on Sept. 21.

The Frankfurt-based central bank is scheduled to hold a six-day fine-tuning operation, or FTO, tomorrow when 225 billion euros worth of ECB loans expire.

“Today’s three-month LTRO would suggest a reduction in the total borrowing or a shift into the six-day operation,” Giuseppe Maraffino, a fixed-income strategist at Barclays Plc in London, wrote in an e-mailed report.

Short Rates

“Both situations would facilitate the ECB resuming its exit strategy by allowing it to drop the full allotment over time at the three-month LTRO,” Maraffino wrote. “This, as much as the change in the liquidity surplus, is likely to push short rates up.”

ECB Executive Board Member Juergen Stark said yesterday the central bank is progressing with its exit from non-standard policy measures.

“We are in the process of phasing out the non-standard measures,” Stark said at a conference in Istanbul. “This week, and in the fourth quarter of 2010, a number of non-standard measures will mature. They will mature and will not be renewed. What we are going to decide for the time after Dec. 31 is up to one of the forthcoming meetings of the Governing Council.”

Three-month Euribor climbed to 0.886 percent today from yesterday’s 0.88 percent, the European Banking Federation said. That’s the highest since Sept. 1 and the largest single-day increase since July 20.

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