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Bank LTRO Repayment Prospects Stoke Bets Borrowing Costs to Rise

Speculation that banks will start repaying European Central Bank loans early prompted futures traders to step up bets that borrowing costs will rise as liquidity is drained from the system.

The implied rate on Euribor futures expiring in December rose as much as 18 basis points over the past two days to 0.54 percent, the highest since July 10, according to data compiled by Bloomberg. That’s the biggest jump since the yield started climbing in December, after a 29 basis-point drop in the preceding three months.

Banks can soon start repaying about 1 trillion euros ($1.3 trillion) of cheap loans that the ECB provided under its longer-term refinancing operations to avert a credit crunch. Concern the Frankfurt-based central bank will tighten its collateral rules also helped push indicators of future interbank borrowing costs higher.

“The repayment of the LTRO money has the potential to throw key market trends into reverse,” Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt, wrote in a note. “Reportedly the ECB is mulling plans to restrict loan collateral. This would add to the pressure on peripheral banks to reduce ECB funding,” though only marginally, he wrote.

The implied rate on three-month euro interbank offered rate futures due in December rose 0.5 basis point today to 0.46 percent at 11:38 a.m. in London. That’s after paring its earlier increase.

Euribor Rising

The three-month Euribor rate was set at 0.209 percent, according to the European Banking Federation. The measure of bank-loan rates is up from a record low 0.181 percent on Dec. 11. It was as high as 5.393 percent in October 2008.

Banks in Europe’s so-called core countries including Germany will probably be the first to repay the ECB loans, according to Deutsche Bank AG.

The ECB is considering new rules that would require banks to provide more information about loans they pledge as collateral for borrowing, said a person with knowledge of the situation who asked not to be identified because the discussions are private.

The ECB is trying to increase the quality of the security it takes in against lending in a move that may end up increasing borrowing costs for banks.

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