A flood of liquidity from central banks again drove down interbank lending rates to record lows on Thursday and narrowed key European spreads that measure stress in the banking system. Financial institutions' overnight deposits at the European Central Bank more than doubled from the previous day, but that was from an artificially low level and so remained well below recent averages.
The Bank of England's decision to leave its key policy rate at 0.5 percent was widely expected, and the Bank didn't adopt further unconventional measures, like cutting its deposit rate on excess bank reserves, which some had thought was an outside possibility.
But the scale of liquidity flooding the short end of sterling, euro and dollar money markets continued to whet investors' appetite for "carry" trades, where cheap short-term funds are invested out the curve or in higher-returning assets.
"There's a lot of cash on the sidelines that needs to be allocated. You have a lot of liquidity, which (is) supportive for carry trades," said Francis Yared, rates strategist at Deutsche Bank in London.
The gap between London interbank offered rates for overnight sterling funds and one-year funds, for example, narrowed to 66 basis points on Thursday, the narrowest since October last year. The comparable euro spread narrowed to around 99 basis points as money market investors ploughed some of that ultra-cheap, short-term money into the longer end of the money market curve for relatively small but easy carry.
London interbank offered rates for dollar, euro and sterling funds across the money market curve from overnight to one-year all fell on Thursday, according to the British Bankers Association fixings. The benchmark three-month rates were set at record lows again. And the difference between euro and sterling Libor and comparable overnight index swaps (OIS) narrowed, and the dollar spread edged up slightly but from very tight levels.
Libor/OIS spreads are a gauge of market stress and credit risk, measuring the difference between the rates at which banks lend to each other and expected policy rates. Meanwhile, financial institutions' overnight deposits at the ECB more than doubled to 76 billion euros, a day after they had tumbled as the ECB drained almost 200 billion euros from the system on the last day of its reserve maintenance period. But that remains well below the average of around 150 billion euros over July and August, analysts say. Market participants continued to focus on the ECB's tender of one-year funds at the end of the month.