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ecb234LONDON: Euro zone money market desks are feeling the unintended consequences of the European Central Bank (ECB) cutting its deposit rate to zero.

The ECB's deposit rate usually acts as the floor for money market rates and represents a safe haven where banks can park money with the central bank to avoid counterparty risk the risk that a private borrower might prove unable to repay a loan.

By cutting this rate to zero, the ECB's intention was to encourage banks to lend euro-denominated funds to their peers given they can earn a higher interest rate, currently about 0.3 percent in the interbank market, by doing this.

While the theory is sound, that is not quite how things are working in practice.

As short-term money market interest rates fall closer to the ECB's zero deposit rate, lenders are earning close to zero for placing deposits with banks for maturities out to three months.

They will see little reason to expose themselves to counterparty risk for this long for very little return and there is anecdotal evidence that some are already reducing the maturity of loans they make to banks.

Traders said some loans to some banks that matured on Friday were rolled over for a shorter period than the original deposit. In some cases, maturing one-week deposits were just rolled over the weekend so that they could be re-assessed on Monday.

Copyright Reuters, 2012

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