Investors priced in a sharp rise in the cost of eurozone overnight borrowing on Tuesday after surprisingly low demand for European Central Bank loans looked set to squeeze banking sector liquidity conditions. Banks opted to renew 218 billion euros of the 284 billion euros of one-week and one-month loans expiring, draining 66 billion euros of excess banking sector liquidity.
That means banks will be bidding in the overnight market for a slim surplus of around 35 billion euros - albeit slightly higher compared to last month when the excess was around 31 billion euros, Barclays Capital estimates showed. "The demand was much lower than expected at both the operations and this should cause a corresponding decline in liquidity. This causes uncertainty and maintains upward pressure on Eonia," said BarCap strategist Giuseppe Maraffino.
After low excess funding caused rates to spike in early February, markets had been anticipating looser liquidity conditions in the new maintenance period - the timeframe over which banks must keep a set amount on deposit at the ECB.
"It's very surprising to me that they only took this much," a trader said. "For the next week at least now funding costs will be very high and the market is nervous." The one-month Eonia rate rose to a peak of 0.82 percent, up 14 basis points from levels seen before the tender.
Eonia forward rates and two-year German bond yields also rose as the short end priced in another bout of upward pressure from diminishing liquidity. The impact of the squeeze also became evident in longer-duration money market rates when three-month euro Libor fixed higher at 1.03500 percent after the tender.
The equivalent Euribor rate, fixed before the tender result, slipped to 1.079 percent - in part due to the anticipation that banks would not allow liquidity to fall to low levels again. The rise in euro-priced interbank rates faltered last week after banks increased their demand for ECB one-week funds.