Euribor lending rates hit their lowest level since October 2010 on Thursday and were likely to fall further after the European Central Bank injected another bout of cash into the financial system to restore confidence in the struggling banking sector. Banks snapped up 530 billion euros at the ECB's second offering of cheap three-year funds on Wednesday.
The extra liquidity will not solve the underlying debt problems in the euro zone, especially as banks increasingly hoard the cash, but it should stave off a credit crunch. The abundance of cash is expected to push key measures of interbank financial stress towards levels seen before the ECB began buying Italian and Spanish bonds in August 2011 to cap a surge in funding costs as market worries about peripheral euro zone debt escalated.
Three-month Euribor rates fell to 0.967 percent from 0.983 percent, hitting the lowest level since October 2010. Simon Smith, chief economist at FxPro, expected the spread between 3-month Euribor and overnight Eonia rates, a measure of counterparty risk, to fall to about 40 basis points by May from around 62 bps currently. The spread was at 35 bps at the beginning of August.
The US dollar Libor/OIS spread stood at 41 bps. But Smith also stressed that the euro zone's underlying problems remained. Alessandro Giansanti, senior rate strategist at ING, said the improvement in funding conditions resulting from the ECB's second three-year long-term refinancing operation (LTRO) could take the Euribor/OIS spread to 30 to 40 bps over the next month.
That would be the floor, he added, because investors would still require a premium for lending cash for three months as opposed to overnight. The overnight Eonia rate at 0.37 percent could not fall much further given it was already close to the 0.25 percent rate offered by the ECB deposit facility, he said.
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