Money markets sub zero depo rate bets linger but likely overdone

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Euro zone money markets still see a slim chance the European Central Bank could cut its deposit rate below zero in coming months but such moves could be overdone given doubts over its efficacy in spurring interbank lending. The ECB left its refinancing rate and the interest it pays banks for using its overnight deposit facility unchanged at 0.75 and zero percent respectively at its policy meeting on Thursday as it prepared to embark on a new bond buying scheme aimed at tackling the euro zone debt crisis. This led markets to slightly scale back expectations of when they expect the ECB to further cut rates. Forward euro overnight Eonia rates, the best gauge for money market expectations of future moves in the ECB's overnight deposit facility rate, are trading as low as 4 basis points for January. This indicated a 25 percent chance of a cut to sub-zero in the deposit rate by the beginning of next year, according to BNP Paribas calculations. A negative deposit facility rate implies a penalty that the ECB would charge banks for parking their cash safely at the central bank instead of lending to each other or to businesses in the real economy.

Analysts said such an unprecedented step now looked unlikely as the ECB still needed to assess the impact of a zero deposit rate which has come under criticism as the non-existent returns have led some big U.S. money managers to restrict access to European money market funds."The ECB itself still hasn't seen the full implications of having a zero depo rate ... so I'm cautious and the market should not run ahead of itself to price in a negative rate," BNP Paribas Matteo Regesta said."The risk of impairing to a serious degree the money market by putting the depo into negative territory and squeezing further money market funds will probably lead the ECB to leave the depo rate at zero. I don't see any benefit to putting the rate below zero."

FRAGMENTED MARKET

The move by the ECB to stop paying interest on banks' deposits has prompted them to make stronger use of the current account facility, which still pays 0.75 percent interest for the required reserves. A total of 342 billion euros was parked in the ECB's deposit facility overnight, latest data showed, down from levels above 800 billion seen before the bank cut the rate to zero in July. Banks' current account deposits at the ECB stood at 535 billion."The problem you have in the interbank market is one of fragmentation and while the ECB's bond purchase plan could help in stabilising markets, it may take a while and more than that for banks to rebuild confidence in each other," a money market strategist said. Commerzbank analysts said the inversion of the forward EONIA curve, where the rates are at their lowest at 4 bps in January/February while flirting around 6-7 bps in the rest of the 2012 strip appeared exaggerated as they still consider a negative depo rate a remote possibility."At these levels, however, the favourable risk-reward in paying EONIA forwards we suggested before is diminishing," they said in a note.