Overnight eurozone interbank lending rates were set to fall over the next week or so after banks kept up their demand for central bank funding, keeping liquidity ample. The European Central Bank lent 129.5 billion euros of three-month funds against a maturing amount of 149.5 billion, but around half that difference was added to one-week funding on Tuesday, leading to a net liquidity reduction of 9 billion euros.
"(The overnight rate) should ease as banks are ahead of their reserve requirements but at the same time term liquidity is declining and this will impact three-month rates...so there could be a steepening of the eonia curve with easing short-term rates and some pressure on three months and beyond," said BNP Paribas rate strategist Matteo Regesta. Morgan Stanley strategists said that excess liquidity in the current maintenance period should average around 35 billion euros, similar to February, where the average Eonia fixing was 0.65 percent according to Reuters data.
Eonia fixings have averaged 0.71 percent so far this maintenance period. In "normal" liquidity conditions, Eonia trades just above the ECB's 1 percent refinancing rate, but the rate has been pushed lower by allowing banks access to as much funding as they need.
The cost of the ECB's three-month longer-term refinancing operations are indexed to moves in the ECB's key refi rate, which many expect to be hiked at least by 25 basis points over the next quarter, with a first rise widely expected next week.
"The cost is exposed to interest rate hikes, and uncertainty about the prospect of those may have caused (the lessened demand)," said BNP Paribas' Regesta. Also, instead of being the last chance for banks to grab unlimited three-month funds as previously expected, the ECB has said it will carry on running such operations until September.
"More demand in shorter maturities could be a positive sign that some banks expect to regain market access over the next 3 months," said Commerzbank rate strategist Christoph Rieger. Benchmark three-month euro-Libor rates nudged up to 1.17500 percent on Tuesday, continuing their rising trend, as the ECB is increasingly expected to raise its key interest rate by 25 basis points next week. All but four out of 80 economists polled by Reuters expected the ECB to hike rates to 1.25 percent next Thursday, with the refinancing rate seen at 1.75 percent by year-end.