Interbank tension surfaces as global worries weigh

Banks increased borrowing from the European Central Bank on Wednesday and sought longer loans, in an early sign that worries over the health of the economy were spilling into money markets. At the ECB's refinancing operations eurozone banks took less one-week money and more three-month loans, leading to a net increase in overall ECB lending of around 2 billion euros.
Safe-haven assets and less risky currencies have rallied strongly this week at the expense of equities due to the bleak US outlook, which threatens to undermine recovery in the eurozone. "Things were going a bit better, but when the stock exchanges went down, you immediately saw the effect of that in the money markets," a money market trader said.
This tension was demonstrated in the short-term markets both by banks' increased reliance on ECB loans and a widening gap between overnight and longer-dated money market rates. Overnight rates - expected to rise as banks are weaned off ECB support - have trended down over the last two maintenance periods because the level of ECB loans in the system has remained relatively constant. On Tuesday, Eonia fixed at 0.41 percent and was seen falling further below 40 bps. Meanwhile, the benchmark three-month interbank Euribor and euro Libor rates have plateaued and show little sign of decreasing, suggesting a renewed reluctance to lend between banks over longer terms.
Three-month euro Libor fixed slightly higher at 0.82875 percent, while equivalent Euribor rose slightly to 0.89 percent. The spread between three-month Euribor and Eonia has widened by 17.5 bps since mid July. With risk appetite suffering globally, pressure appears to have resumed on the eurozone's higher-yielding states, adding to interbank tension.
"I would see this against a background of renewed, increased tension in peripheral sovereign bond markets," said Klaus Baader, chief European economist at Societe Generale. Ireland's credit rating was cut late on Tuesday with rating agency Standard and Poors citing the cost of supporting the ailing Irish financial sector. The tension in markets over the global outlook was also seen in interest rate swaps where the 10-year euro swap rate sank to a new record low and 30-year swaps again fell.