Money markets ecb cash keeps pushing interbank rates lower

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* Euribor, Libor rates keep falling on ECB cash bonanza* Lower state borrowing costs help as well* Any step back in fixing euro crisis could halt the trendBy Marius ZahariaLONDON, Feb 20 The prospect of another large ECB cash injection pushed euro-priced bank-to-bank lending rates to a new one-year low on Monday, a trend that should continue as long as efforts to cut debt and address the euro zone's structural flaws are sustained. Worries about euro zone banks' exposure to heavily indebted sovereigns such as Spain and Italy helped keep interbank lending rates elevated throughout 2011, but those concerns seem to be receding with states' borrowing costs. The game changer has been the 489 trillion euros worth of three-year loans that the European Central Bank pumped into euro zone banks in December. Banks are expected to take a similar amount of cash at another such liquidity operation on Feb. 29."There is this whole new world in which banks are more stable and as long as that's happening you get the fixings coming down," said RBC Capital Markets' head of European rates strategy Peter Schaffrik.

"You don't only have liquidity, but on top of that comes the sovereigns. The less shaky the sovereigns are, the better it is for the banking system. So what was a negative feedback loop at the end of last year turns now into a positive feedback loop."Three-month Euribor rates, traditionally the main gauge of unsecured interbank euro lending and a mix of interest rate expectations and banks' appetite for lending, fell to 1.031 percent from 1.036 percent, hitting their lowest level since January last year. Equivalent Libor rates, fixed in London, dropped to 0.95750 percent from 0.96536 percent.

SLOWING DOWN Bank-to-bank lending rates have fallen by almost a third since late November. Even last week's worries that Greece might fail to reach a second bailout deal and head towards a disorderly default could not halt the trend, as the liquidity factors driving it were simply too strong, according to traders. The mood around Athens has since improved and Europe is expected to sign off on a second Greek bailout package later on Monday, leaving few obstacles in front of falling rates.

But with three-month Euribor rates now close to the ECB's key rate at 1 percent, some analysts expect the trend to lose some of its pace. Signs the euro zone economy is stabilising have also prompted economists to revise predictions the ECB will cut interest rates from a record low 1 percent, and a Reuters poll following this month's policy meeting saw little or no change this year. Barclays strategists expect the rate of decline to roughly halve to 0.4 basis points a day or less, settling at around 0.95 percent in mid-March and 0.80 percent by the summer. The falling trend in interbank rates is also driven by expectations that euro zone politicians will continue to pursue debt-cutting reforms and make progress on fixing the currency union's major flaws, such as the lack of fiscal unity. Any step back will heighten sovereign risks and reignite banking concerns as well, which could stop or even reverse the trend in lending rates, analysts say."If at some point European leaders decide that they've done enough, that would be a policy mistake," said Elwin de Groot, a senior market economist at Rabobank."The (three-year cash injection) is a liquidity solution and not a structural solution to systemic risks, which are much more linked to the flaws such as the lack of fiscal union. They have to make more advances there to cement the (trend)."De Groot said the floor for the current trend should be higher than levels seen before the euro zone crisis escalated. In April 2010, before Greece was given the first bailout, three-month euro Libor was fixing just below 0.60 percent, while Euribor fixings were a few basis points above that level.