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Interbank rates fall further with more seen ahead

Since October, euro and sterling rates and spreads have tracked their dollar equivalents lower, mainly driven by central bank moves to flood financial institutions with unprecedented amounts of cash and the Fed’s step to slash its target interest rate to near zero in December.

But despite the recent fall in Libor rates, activity on interbank markets remains sticky when it comes to borrowing funds for more than three months, traders said, with offers still said to be highly name sensitive.

However, a pick up in corporate debt issuance this month reflects some easing in credit conditions, with more than 18 billion euros ($23.9 billion) worth of euro-denominated non-financial new bond supply snapped up by investors so far in January, according to data from SG CIB.

“You get a lot of money coming through in January and most of these deals have been very subscribed. If they’re borrowing from the market then they’re not borrowing from the banks and that frees up credit lines,” said Calyon rate strategist David Keeble.

In ongoing operations to supply funds to the market, the European Central Bank added a total of $58.8 billion in U.S. dollar liquidity on Wednesday, via an FX swap and its latest offering of dollar funding. The Bank of England said it received no bids in an equivalent auction for 7-day dollar loans.

Despite the free flow of funds, banks still preferred to do business with their central banks rather than lend on interbank markets, with overnight deposits at the ECB easing back from the record high hit on Monday but still remaining above 300 billion euro for the third day in a row [ID:nFAT004525].

The amounts flowing through the ECB’s overnight facilities remain well above levels when markets were functioning properly. But from next Wednesday the ECB will increase the gap between its main interest rate and overnight deposit and lending rates to make borrowing and depositing cash overnight less attractive—its latest attempt to kick start the bank-to-bank lending market again.

Euro markets subdued ahead of ECB

The three-month dollar London interbank offered rate (Libor) was fixed at 1.083 percent on Wednesday, according to the latest fixings by the British Bankers’ Association—the lowest since June 2003 [ID:nLE675594].

The spread of three-month dollar Libor over anticipated central bank rates, or Overnight Index Swaps (OIS), held at 93 basis points, its narrowest since mid-September around the time of the collapse of investment bank Lehman Brothers, Reuters data showed.

But it remained well above levels of around 10 basis points seen consistently before the global credit crisis erupted in August 2007.

The forward spread of three-month Libor/OIS rates shows a contraction to around 68 basis points by the end of March for euros from the current 108 basis points and to around 65 basis points for dollars, according to ICAP data.

“If you look at the forwards, it gets to the end of Q1 and the contraction in spreads really slows down quite quickly,” said Calyon’s Keeble.

“Lots of the government plans that are coming into force are very short-term and they’re all up and running by the end of the first quarter so if things don’t improve by then, then it’s not going to improve much thereafter.”

Traders also said market activity in euros was subdued with the focus in Europe turning to Thursday’s ECB interest rate decision where the bank is expected to cut interest rates by 50 basis points to 2.0 percent.

However, financial markets are still divided on how fast it will proceed with its campaign to fend off a deeper recession.

A Reuters poll last week showed that more than three-quarters of economists -- 55 out of 70 -- expect a cut on Thursday. Most opted for a 50 basis point reduction but nine of them forecast a more modest 25 point move.

With no recovery in sight, a majority of economists expect the ECB to keep cutting for much of the first half of the year. Figures derived from EONIA rates show official rates could bottom out at 1.00-1.25 percent ECBWATCH