The stress affecting the interbank lending market looks set to remain high in the medium term, analysts said on Tuesday, with the rapid deterioration in funding conditions seen in recent weeks set to hamper markets for months to come. As worries over the health of eurozone sovereigns have spiralled, stress indicators in the vital short-term lending markets increasingly point to a dwindling appetite to lend between banks, creating the extra effect of spooking overseas lenders.
Markets show stress has edged back from its worst levels but the impact on sentiment and effects of increased dependence on long-term emergency loans from the European Central Bank mean a return to freer lending between banks will be slow in coming. In response to a rapid worsening of the sovereign debt crisis, which threatened to envelop Italy and Spain, the ECB backtracked on attempts to withdraw banking sector support and offered an unlimited amount of six-month loans. "Without the ECB liquidity facilities I think we would have had a situation similar to that before Lehman Brothers collapsed - no trust between banks and no interbank lending," said Barclays Capital strategist Giuseppe Maraffino.
The ECB's emergency six-month buffer attracted 50 billion euros of bids from banks struggling to find long-term funding elsewhere, helping to prevent a full-scale funding squeeze while artificially lowering interbank rates and distorting money markets.
Despite lower outright interbank rates, indicators such as the euro Libor/OIS spread, which shows the market valuation of counterparty risk, have more than doubled since late July. On Tuesday the spread eased to a still-elevated 58 basis points from a peak of above 60 bps. A tentative recovery of riskier assets and less volatile trading conditions have seen the three-month euro/dollar swap rate ease to -84 bps, but the key funding rate remains within touching distance of its most expensive since late 2008, seen last week at -95 bps.
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