Money markets euro interbank rates seen reversing falling trend

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* Futures contracts pointing to Euribor trend reversal* Greek, Spanish banks worries driving futures sell-off* Buying opportunity for those betting on ECB easingBy Marius ZahariaLONDON, May 14 Future interest rate markets signal the sharp falling trend in benchmark interbank euro rates is nearing an end as the threat of a Greek exit from the currency bloc and worries about Spanish banks outweigh the effect of abundant ECB cash. The June Euribor future was 2.5 ticks lower on the day at 99.30, implying the three-month Euribor rate is expected to settle at 0.70 percent next month, compared with a fixing of 0.689 percent on Monday - a two-year low. The contract has been gradually falling after Greece elected mainly anti-austerity politicians last week, raising the risk that Athens will not stick to its bailout deal, which could lead to another default and potentially force it out of the euro.

Spanish banks' troubles in coping with their bad mortgage loans have also been weighing on Euribor futures contracts. June Euribor traded at 99.40 before the Greek elections, implying expectations that the Euribor rate will fix at 0.6 percent. The fall on Monday marks a turn-around in expectations of where Euribor rates were heading from next month."The whole risk off environment is really leading it ... you see capital stress with the recap (bank recapitalisation) exercise in Spain and the peripherals under pressure again," said Peter Schaffrik, head of European rates strategy at RBC Capital Markets. The three-month Euribor rate, traditionally the main gauge of unsecured interbank lending, has more than halved since late November, when the European Central Bank's two tenders of unlimited three-year loans were first announced.

The massive take-up by banks has brought the excess liquidity in the banking system to a whopping 800 billion euros . But that may not be enough, some analysts say, as the consequences of a potential Greek euro exit were unclear."In time, banks will run out of this liquidity. Bonds need to be redeemed, pre-funding is required," BNP Paribas rate strategist Matteo Regesta said."Possibly the level of excess liquidity, in the absence of further measures, might decrease as we move towards the second half of the year and in the case of a fallout from Greece the ECB might be forced to do more."

A Reuters poll showed 15 out of 25 money market traders did not expect the ECB to conduct any more three-year operations this year. That was a significant change from an April survey, when none of the 26 traders expected the ECB to move again. The possibility of more monetary policy easing from the European Central Bank, although not the central scenario for markets at the moment, inspires those who are buying Euribor futures contracts at the moment. Lena Komileva, managing director and chief economist at G+ Economics, recommends investors to bet against the current trend and buy Euribor futures <0#FEI:> on the longer end of the 2012 strip. The September and December contracts underperformed the rest of the strip, and were both down 5.5 ticks at 99.31 and 99.30 respectively."The sharp sell-off in Euribor Sep12 and Dec12 contracts, combined with higher than expected Euribor fixings since the weekend elections... signal an adverse turn in the euro money markets liquidity cycle," Komileva said."This offers a cheap opportunity to pick up upside potential into the second half of the year as escalating market stresses shape the ECB response towards another rate cut."RBC's Schaffrik, on the other hand, said he had "no convictions" on the Euribor trend at this point and that he would watch future moves from the sidelines.