MONEY MARKETS-Libor rates extend decline, euro hits fresh low
* Three-month euro Libor hits all-time low, extending fall
* Overnight deposits at ECB rise to 5-1/2 month high
* Rising China repo, FRA rates spark talk of tighter policy
By Ian Chua
LONDON, July 3 - Bank-to-bank lending rates for euro funds fell to fresh lows on Friday, a day after the European Central Bank kept its benchmark rate at 1.0 percent.
ECB President Jean-Claude Trichet said the ECB, which will start buying covered bonds next week, was happy with the results of its 442 billion euro injection of 12-month funds last week, which have pushed money market rates to all-time lows.
His comments helped eased market worries that the ECB was unhappy with the slide in the Euro Overnight Index Average <EONIA=>, the overnight reference rate for the euro, to a record trough of 0.344 percent this week.
It was well below the ECB's benchmark refinancing rate of 1.0 percent and nearer to the deposit rate of 0.25 percent.
Analysts said euro money market rates were likely to remain low in a system flush with liquidity, although excess funds will start to drain off slowly as shorter dated borrowings rolled over.
"The excess liquidity we have right now will decrease going forward but at a slow pace, so that will continue to support low Eonia fixings on average," said Guillaume Baron, rate strategist at Societe Generale in Paris.
Eonia was fixed at 0.360 percent on Thursday, while the one-week Eonia <EUREONSW=> last traded at 0.405 percent, steadying having fallen as low as 0.357 percent on June 26.
The three-month euro London interbank offered rate was fixed at 1.03750 percent <EUR3MFSR=>, while the equivalent rates for dollars and sterling were also eased to all-time lows. See [ID:nL3684645] for latest Libor fixings.
The three-month Euribor <EURIBOR3MD=>, traditionally the main gauge of interbank euro lending, fell to an all-time low of 1.059 percent.
SITTING TIGHT
"We suspect that the ECB will sit tight for the moment and let very loose liquidity conditions solve themselves," said Mikael Nilsson at Barclays Capital.
"From current levels, though, it is going to take some time for sub-six months Eonia to rally further, if at all. With the back end not really moving much, and being, at most, fair at this stage, we see little further room for a rally."
While the provision of the liquidity technically encourages the supply of credit, it only does so if the banking sector is in good shape, with healthy balance sheets, said Charles Diebel, strategist at Nomura.
"If not, then the risk is that liquidity is hoarded and recycled into the bond market," he said.
Commercial banks deposited 287.7 billion euros at the ECB's overnight facility -- a 5-1/2 month high -- on July 2, suggesting banks would rather park excess liquidity at the central bank rather than lend them on as they continued to mend their balance-sheets battered by the credit crisis.
In Asia, a jump in yields at China's auction of bills this week drove other short term rates higher and stirred speculation the central bank may be stealthily tightening monetary policy.
At the regular Thursday auction of 3-month bills, the People's Bank of China sold 50 billion yuan worth of the bills at 1.0279 percent, a jump from last week's 0.965 percent, which had held at the previous 22 auctions.
Barclays said this was not the start of a tightening of broader monetary policy, even though the Chinese central bank was worried about credit expansion and the eventual rise in rates, such as through higher reserve requirements, could come earlier than expected.