Euro Money Market to Get Little Stress Relief From ECB Rate Cuts

Estimates of future interbank euro borrowing costs fell to a record after today’s European Central Bank rate cuts, heightening concerns that ultra-low returns will further dissuade banks from lending to their peers.

Three-month swaps linked to the euro overnight index average, or Eonia, fell to as low as 12.6 basis points after the ECB lowered its deposit rate by 25 basis points to zero percent. The measure of overnight unsecured lending transactions, the so-called Eonia-OIS swap, has fallen from 39 basis points at the start of the year.

“The Eonia-OIS is likely to fall lower, and that may kill the interbank market because you’re taking such a large credit risk relative to the revenue you’re getting,” said Robin Belec, chief operating officer at In Touch Capital Markets Ltd. in London. “Banks that are short of liquidity may become more dependent on the ECB despite the zero deposit rate.”

The decline in Eonia-OIS has accompanied a drop in the volume of overnight lending as measured by the European Banking Federation in Brussels as part of its daily survey of interbank activity. About 22.4 billion euros ($28 billion) of transactions were recorded in the Eonia market yesterday, compared with a five-year daily average of 36 billion euros.

The Eonia-OIS swap was 13.7 basis points at 5 p.m. in London, according to data compiled by Bloomberg. The rate was 22 basis points before the ECB’s announcement.

ECB policy makers also cut the main benchmark rate by 25 basis points to 0.75 percent at today’s meeting, which took place six days after European leaders’ latest summit to resolve the sovereign crisis.

Basis Swap

The cost for European banks to borrow in dollars rose to the highest in four months. The three-month cross-currency basis swap, the rate banks pay to convert euro interest payments into dollars, was 69 basis points below the euro interbank offered rate, the highest cost since March 5, from 58 yesterday.

The one-year basis swap was 55 basis points below Euribor from minus 52 yesterday. Euribor is the rate banks say they see each other lending in euros and is derived from a survey by the European Banking Federation.

Prices in the forward market for three-month Euribor relative to overnight indexed swaps -- known as the FRA/OIS spread -- rose to 30 basis points from 28. An increase signals banks are less willing to lend.

Three-month Euribor fell to 0.641 percent from 0.645 the day before. The rate reached a record low of 0.634 percent on March 31, 2010. One-week Euribor fell to 0.313 percent from 0.317 percent.

The London interbank offered rate, or Libor, for three-month dollar loans was unchanged at 0.460. Libor, which acts as a benchmark for about $360 trillion of financial instruments worldwide, is published by the British Bankers’ Association.

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