August 21, 2012 / 3:42 PM / 5 years ago

MONEY MARKETS-Euribor rates hit new lows, pace of decline slows

LONDON, Aug 21 (Reuters) - Bank-to-bank lending rates hit new record lows on Tuesday on persistent expectations for further monetary easing b y the European Central Bank as early as September, but the pace of their decline slowed.

Three-month Euribor rates have hit all-time lows on a regular basis since the ECB's monetary policy meeting this month when chief Mario Draghi said the bank's policymakers discussed cutting rates but decided to keep them on hold.

With the euro zone on the brink of recession and the debt crisis still unresolved, a recent Reuters poll forecast the ECB would reduce interest rates by 25 basis points to 0.50 percent at its next meeting on Sept. 6.

Lower interest rates, however, are not expected to do much to jump-start a flailing economy - given how low bond yields are already. Market players will be focusing on what Draghi says at his Sept. 6 press conference amid expectations the bank will soon unveil a plan to curb Italian and Spanish borrowing costs.

"The market will be disappointed if the ECB does not act, does not buy bonds in the market in September," Alessandro Giansanti, strategist at ING, said.

"What will be important will be the size (of any intervention), which part of the curve. If it is only going to buy in the short end, who will be buying in the long end? Maybe the EFSF (euro zone rescue fund), how will the EFSF will be financed?"

Three-month Euribor rates, traditionally the main gauge of unsecured bank-to-bank lending, eased to 0.318 percent from 0.325 percent on Monday.

It has become increasingly difficult to use Euribors to gauge interest rate expectations given the artificially high amount of liquidity out there, but Giansanti said Euribor futures were fully pricing in a 25 basis point rate cut next month.

The pace of the decline in the three-month Euribor rate has slowed, however. Barclays analysts, in a research note, said that the rate had dipped by 0.38 basis points per day on average compared to 0.44 bps and 0.8 bps in previous weeks.

Simon Peck, strategist at RBS saw the three-month Euribor rate stabilizing at around 0.28 percent ahead of the ECB meeting in early September.

"A lot of the move has come on the original headlines, and I think it makes sense that we will see a plateau as we go forward from here," Peck said.

FAVOURABLE BACKDROP

Expectations have been high since Draghi's recent pledge to do what was necessary to preserve the euro and his indication that the ECB could resume its bond-buying programme on condition that governments request aid from euro zone rescue funds first.

His comments that any bond-buying would be focused on short-dated paper has helped to support the front-end of Spanish and Italian yield curves and provided a favourable backdrop to a sale of 12- and 18- month T-bills on Tuesday.

The Treasury in Madrid sold 4.5 billion euros ($5.6 billion) of the paper at significantly lower yields than last month, but at above 3 percent, borrowing costs remained punishingly high.

One-year Spanish yields were down 15 basis points at 3.2 percent and the equivalent Italian yield shed 6.7 bps to 2.4 percent in the secondary market.

Any sell-off is only likely to make that part of the curve more attractive, the Barclays analysts said.

"If the situation improves and Italy and Spain are able to rebuild market credibility without further intervention, we would expect the front end to rally from its current cheap level," they said.

"If tensions increase and force Spain and/or Italy to require a formal EFSF/ESM intervention, the front end should eventually benefit from ECB buying."

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