Coeure Says ECB Loan Repayment Won’t Affect Overnight Rates

European Central Bank Executive Board member Benoit Coeure said he doesn’t expect much of an effect on overnight interbank rates from early repayments of three-year loans to banks that can begin as soon as this month.

“We don’t have a normative or prescriptive view on whether banks should repay the LTRO” early, Coeure said at an event in Paris today, referring to the ECB loans, known as longer-term refinancing operations. “Will it have a big impact on the money market? I don’t expect it to have a big impact.”

The Frankfurt-based ECB flooded financial markets with more than 1 trillion euros ($1.3 trillion) in cheap three-year funds starting in December 2011 to bolster Europe’s financial system. With a fragile recovery in market confidence under way, investors are testing the ECB’s attitude to loan repayments for signs it may tighten credit as it maintains its benchmark interest rate at a record low.

The euro fell against the dollar after the comments and was down 0.4 percent at $1.3322 as of 4:00 p.m. Frankfurt time. It reached $1.3404 on Jan. 14, the strongest since Feb. 29, 2012. German bonds rose, with 10-year yields falling from the highest level in three months, to 1.58 percent.

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

‘Satisfactory’ Conditions

ECB President Mario Draghi, who introduced the long-term loans in his second month at the head of the central bank, said last week that funding conditions in markets are currently “satisfactory” and that banks could pay back the funds in weekly installments. The first three-year loan, from December 2011, can be paid back from Jan. 30, and the February 2011 tender can be repaid from Feb. 27.

Coeure’s comments suggest the ECB isn’t actively encouraging banks to pay back the loans and thereby attempting to tighten money-market conditions as a nascent recovery gathers pace, said Ken Wattret, chief euro-area economist at BNP Paribas in London.

“If the ECB continues to give the impression that it is done easing, it runs the risk of an unwelcome tightening of monetary conditions via the exchange-rate channel,” Wattret said. “This could be interpreted as a rowing back of sorts.”

ECB non-standard monetary policy measures, ranging from the three-year loans to the OMT bond-buying program announced in September, produced relative calm on financial markets as political leaders made progress last year on reforming bringing the euro-area’s 17 economies closer together in a bid to mend the causes of the debt crisis. The ECB’s benchmark interest rate stands at 0.75 percent, and the deposit rate is at zero.

Positive Contagion

While Draghi last week hailed the “positive contagion” in financial markets, he also warned that it’s too early to declare victory over the debt crisis. The central bank forecasts the economy will return to growth in the second half of this year.

As the recovery takes hold, Coeure said that there’s no compulsion to repay the loans.

“We’ve given them an option, they’ll exercise it, and they can do so in a continuous way over time,” he said. “I don’t expect the repayments to have a major impact on Eonia, given the excess liquidity in the euro area, which remains significant and that depends fundamentally on the economic situation.”

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