Intensifying bond market anxiety centred on Italy and impending bank stress test results look set to drive interbank funding rates higher and boost demand for European Central Bank loans. Bank-to bank lending rates rose on Monday on signs the eurozone debt crisis is escalating to a new level as investors turn their fire on Italy, the euro zone's most heavily indebted state.
The benchmark London interbank offered rate (Libor) for three-month funds rose by the largest amount since early May to 1.54563 percent, its highest level since March 2009. Equivalent euribor rates also rose. Libor rates have been on an upward path over recent months due to the ECB's rate hiking cycle, and analysts said souring market sentiment was giving rates a further push higher by making banks less willing to lend to each other on an unsecured basis.
The deteriorating appetite for interbank lending was likely to push more banks to take funding from the ECB rather than sourcing credit from the market. Demand for ECB cash was likely to increase at one-week and one-month funding operations later this week, when around 190 billion euros ($275 billion) of loans will expire.
"I would not be surprised if we see an increased takedown. We've seen before in severe stress scenarios that this is what's most likely going to happen," Peter Schaffrik, head of European rates strategy at RBC Capital Markets. Bond market concerns over the sustainability of Italy's sovereign debt added to concerns about the capital strength of its banks - large holders of these bonds - before stress test results due later this week. Such concerns have added to volatility in Italian banking shares and prompted regulators to seek disclosure of certain short positions.