Money markets sub zero ecb deposit rate no longer unthinkable

← Homepage

Euro zone money markets have been wary of pricing in any prospect that the European Central Bank might cut its deposit rate below zero, but there are signs that such an unprecedented move is no longer considered unthinkable. The forward euro zone EONIA overnight interest rate for December traded at 6 basis points on Friday, less than the average spread of 8 basis points over the ECB's depo rate seen in the past few months. The rate projected for December is just half of Thursday's 0.12 percent EONIA settlement and indicates that the market is pricing in a tiny possibility that the ECB deposit rate may go below zero later this year."It does not seem to have been any serious flows in the market yet, but some in the market are starting to talk about this," said Max Leung, an interest rate strategist at BofA Merrill Lynch Global Research. Recent comments from ECB policymakers suggested that the central bank is keeping the door open for further easing, but the form any such step would take is unclear.

If the ECB ever does cut its refinancing rate from the current record low of 0.75 percent, the question arises whether it will keep the gap over the depo rate at the usual 75 basis points. If the deposit rate turned negative, the ECB would have to change the way it manages banks' excess reserves in the current account as well if it wants to penalise banks for parking cash in the ECB's safe coffers rather than lending to each other or to businesses. The only certainty in the market about the ECB's next move is that it will not cut the depo rate again in the near future, because it will take several months to assess the full impact of the July 5 cut to zero.

Many are already expressing serious doubts that the zero rate will spur activity in the interbank market and filter through to the real economy. In fact, some of the biggest money managers have already restricted access to European money market funds due to the almost non-existent returns. Besides, most banks are not lending because they do not trust each other and that may not change even if they are penalised for it."In an environment where it is return of capital that counts, rather than return on capital, you may well have to pay someone to be the guardian of your money," said Simon Peck, rate strategist at RBS.

"Just because the deposit rate is zero or going lower doesn't necessarily imply that straight away you can change your risk management framework."Peck said a further cut in the depo rate would push returns on short-term bonds issued by top-rated countries such as Germany even deeper into negative territory. Two-year German yields last traded at minus 0.06 percent."Theoretically, it's even possible for Eonia rates to go negative going forward," said Peck. BofA Merril Lynch's Leung said Euribor futures , which currently trade around 99.60-99.65 on the 2012 strip -- implying the euro zone benchmark three-month interbank Euribor rate could fix at 0.35-0.40 percent later this year -- could "trade somewhere at 99.90, 99.95 or even 100."Three-month Euribor hit a new all-time low of 0.451 percent on Friday, fixing below the three-month dollar Libor for the first time since the beginning of 2008 in a sign of just how loose monetary conditions are.