Money markets ecb borrowing falls but cash surplus here to stay

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* ECB borrowing down 20 bln euros, excess to remain large* Huge surplus after 3-yr operation to keep rates ultra low* Reserve requirement cut, Feb long-term tender to boost cash surplusBy William JamesLONDON, Jan 10 Euro zone banks cut their weekly borrowing from the European Central Bank by 20 billion euros on Tuesday, but the huge cash surplus providing life-support to the banking sector looks set to remain over the long term. Banks' need for short-term loans typically falls as the demand for cash to place on reserve at the ECB eases towards the end of a monthly cycle, but the decline has been accelerated by the central bank's provision of more, longer-term loans. This was reflected in falling demand for the ECB's weekly funding injection. Borrowing fell to 110.9 billion euros, down from 130.6 billion euros last week. Euro zone banks took up 489 billion euros late last month in the first of two opportunities to access the three-year loans - operations the ECB hopes will minimise the chances of them slashing lending in response to the region's debt crisis.

Despite the decline in week-to-week funding, the amount of cash in excess of what the ECB estimates banks need was set to keep rising and remain high over at least the next year. As a result overnight rates are anchored at rock-bottom levels and longer-term rates look likely to extend their falls."It's definitely suppressive. It keeps short-dated rates subdued and that's why you're seeing the (German two-year) Schatz where it is, Euribor has been falling, Eonia remains subdued and will remain that way," said Orlando Green, strategist at Credit Agricole in London.

Both Libor and Euribor - benchmark rates for unsecured lending between banks - have tumbled since the ECB cash injection in December while the overnight Eonia rate hovers at 0.372 percent, just 12 bps above the central bank's deposit rate. Three-month Euribor fell to 1.267 percent, the lowest since early April and down from 1.276 percent on Monday. Barclays Capital strategists estimate the rate could continue to fall, reaching 1 percent in the next few weeks. The equivalent Libor fixing fell to 1.20929 percent, down for the 14th consecutive session.

RISING LIQUIDITY TIDE The anticipated rise in excess liquidity, which currently stands at 422 billion euros according to Reuters data , was seen coming from two sources. Firstly, the ECB decided in December to halve the amount of cash it requires banks to keep on reserve. This means that from the beginning of the next maintenance period on Jan. 18, banks will have more available funds."The three-year (lending operation) itself amounts to 489 billion euros - thus creating excess liquidity of more than 300 billion for at least the next 12 months... regardless of the actual funding conditions in the market," said Barclays Capital rate strategist Giuseppe Maraffino in a note. Secondly, another opportunity to take out three-year loans at the ECB in February was also seen likely to attract significant demand, analysts said, underscoring the view that excess liquidity would remain high, and interbank rates low."I think the banks will take up the opportunity. At this stage it makes sense for banks to continue to get involved and then if they don't want it then after a year they can opt out," Credit Agricole's Green said.