FRANKFURT (MNI) – With a total of E140.6 billion allocated at
Wednesday’s 3-month LTRO, up from the E132.2 billion maturing, it seems
clear that banks are still keen to top up with cash at least until the
end of 1Q next year.

The extra uptake boosts excess liquidity levels, which stood at
E168 billion on Friday, by E18 billion from the start of the week.

Much of that excess liquidity has been re-deposited in the ECB’s
deposit facility. On Monday, E165 billion was parked there, the highest
since early September and well above the corresponding days of the
previous maintenance period.

On Tuesday, banks stocked up on one-week funding, taking E208
billion at the ECB’s main 7-day refinancing operation — the highest
volume since February.

Analysts at Barclays say this suggests that borrowing has increased
not only because of real liquidity needs but also for precautionary
reasons — to meet reserve requirements, for example.

A notable feature of the large amount of liquidity available to
banks has been the downward pressure it has exerted until recently on
Eonia rates, which until about a week ago had been trading well below
the ECB’s refi rate, and close to the discount rate, currently at 0.75%.

However, in a recent and atypical shift, Eonia has traded above
1.0% for the past week. That is around 15 basis point higher than what
might be considered fair value.

Analysts at Barclays attribute the recent upward pressure on Eonia
to a number of banks that are bidding aggressively in the unsecured
overnight liquidity market.

Though a significant number of banks are willing to rely on the ECB
for funding, Barclays said, there are still a number of institutions
that perceive a stigma attached to over-reliance on the central bank’s
full allotment facilities. They prefer to secure their funding in the
market, bidding aggressively to obtain it.

Reinforcing the upward pressure on short-term rates is the fact
that many banks are simply redepositing their cash at the ECB deposit
window, as the E165 billion in that facility abundantly demonstrates.

Yet another factor behind the recent spike in Eonia is that
expectations of a rate cut at the next ECB monetary policy meeting on
October 6 have begun to recede.

Speculation of a rate cut were stoked after Luc Coene, Belgium’s
central bank governor, hinted that the ECB could act to address risks to
growth at its next meeting “if the data in early October show that
things are worse than we anticipated.”

Expectations waned, however, when ECB Council Member Yves Mersch
outright rejected any speculation of a sharp 50 basis point cut.

“These wild expectations only show that some people have lost the
north,” he told Market News International, in a reference to the
often-cited ECB priced stability compass,” Mersch said.

Of course, a cut in the refinancing rate cannot be ruled out,
especially given that the ECB’s Governing Council meeting is still a
week away, and in the current financial environment an awful lot can
happen in seven days.

Even if, as seems likely from today’s vantage point, the Governing
Council keeps the key policy rate on hold, it might still decide to
reduce its deposit rate, thus widening the rate corridor and dissuading
banks from over-using the overnight deposit facility.

Another move the bank is clearly contemplating, as several ECB
officials have made clear recently, is a re-introduction of fixed-rate
one-year tenders with full allotment.

The 1-year LTRO was last offered in 2009, when the ECB held three
such operations. Borrowing was huge at the first one but fell markedly
in the subsequent two operations.

If the ECB does renew the 12-month LTRO, it is likely to make the
announcement at its October meeting.

Barclays predicted that bank participation in such an operation
would be high, since the increased volatility and uncertainty over
funding conditions would make the predictability of financing that such
an operation provides extremely attractive.

–Frankfurt Bureau: +49 69 720 142; email:–

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