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Money markets interbank pipelines still frozen in euro zone

* Interbank lending volumes steady in January, despite excess cash* Any improvement is expected to be slow, policy dependant* Greece, Portugal hurting confidence among banksBy Marius ZahariaLONDON, Jan 31 Euro zone interbank lending activity is yet to pick up after the first month of the year in a sign that policymakers must complement the ECB's massive cash injections with bold reforms to restore confidence. The European Central Bank threw almost half-a-trillion euros at the banking system in late December via an auction of unlimited three-year euro loans, and banks can take as much cash as they want in another such tender next month. The availability of "easy money" should erase any bank funding concerns for the next three years and normally encourage banks to lend to each other at least on a short-term basis. But the rift between the few top-rated banks in northern Europe and the rest of the euro banking sector that was opened up by the Lehman Brothers collapse in 2008 and widened during the three-year-long sovereign debt crisis is hard to repair. Analysts say an increase in interbank lending activity, seen as key to bringing the euro zone economy back on a growth path, will be a slow process and a lot more policy effort is needed.

A plan to strengthen fiscal unity within the euro zone, a lack of which many economists say is at the root of the current problems, is only in its inception phase, unemployment is high around the bloc and fiscal deficits are naggingly large. Also, risks that the currency union could break up persist, with a vital Greek debt swap deal yet to be reached and fears growing that Portugal will be the next to restructure its debt."We haven't seen much activity in the interbank market despite lower rates. If I'm long cash, why would I lend at lower rates? If I have some confidence in the whole political process I might, but at the moment this is still lacking," a trader said. The average daily volume in the overnight Eonia euro lending markets in January was 30.27 billion euros, little different to December or November and significantly down from 45.4 billion euros in January last year, according to Reuters data.

In September 2008, just before the situation started to unravel, daily Eonia volumes reached over 70 billion euros. One head of money markets at a bank in London who declined to be named saw no signs of pick-up in activity for longer maturities either."Some larger names are talking of an increase in activity perhaps ... (But) from what I see there has been no pick-up in interbank lending activity," he said. FROZEN PIPELINES

A large take-up at February's ECB three-year cash tender may still go a long way in gradually restoring confidence between banks and their counterparties. Expectations about the amount to be taken by banks are on the rise. A Reuters poll showed markets expected the ECB to allot 325 billion euros in three-year loans in February, compared with 263 billion in a previous survey. This is improving sentiment in other asset classes, with short-term debt rates across the euro zone having come down sharply in the past two months and equities rallying. Interbank lending, however, will probably be slower to react."If I have some internal lending restrictions for individual countries themselves or a particular group of banks within a country, I'm going to be cautious still until I have more information about the extent to which they participated (in the first tender)," FXPro chief strategist Michael Derks said. One worry is that, trying to secure ECB loans, some banks bought even more low-rated state debt to use as collateral, thus increasing their exposure to sovereign debt. Analysts say that as banks gather more information about the impact the first tender had on the balance sheets of their counterparties, they might be willing to unclog some of the credit lines."That may come to some degree in March perhaps. The issue is that Portugal is starting to implode ... That will freeze the pipelines again," Derks said.

Money markets markets ready for ecb rate cut this week

* Rate cut bets remain despite EU summit outcome* Expectations based on deteriorating economy* Cut seen improving sentiment more than economyBy Ana Nicolaci da CostaLONDON, July 2 Money markets expect the European Central Bank to cut interest rates this week as the euro zone economy struggles, with policy action at the European Union summit having provided only fleeting relief to volatile sovereign debt markets. Forty-eight of 71 analysts expect the ECB will trim interest rates on Thursday, with most predicting a 25 basis point cut to 0.75 percent, where they will stay until 2014 at least. . The survey was taken before European leaders decided on a more flexible use of euro zone rescue fund last week, but given recent economic data and rhetoric from ECB policymakers, analysts are still betting on more monetary easing. Joblessness in the euro zone rose to a record high in May and lending to European firms contracted that same month, piling further pressure on the central bank to act."What has come out from the (summit) meeting can be a positive first step but is not conclusive or what is needed to tackle the crisis and tensions in the interbank market. So I expect ECB action, even if we are not sure that it will be so effective for the economy given that rates are already very low," Alessandro Giansanti, senior rate strategist at ING said. European leaders decided last week that euro zone rescue funds could be used to stabilise bond markets without extra austerity measures and recapitalise banks directly without increasing the country's budget deficit.

The outcome gave some relief to sovereign debt markets but had little impact on money markets, which are still discounting more monetary easing. CRACKS APPEAR There were already signs that the measures agreed - which surpassed market expectations - could face obstacles. The Finnish government told parliament on Monday that Helsinki and a like-minded administration in the Netherlands would block the euro zone's permanent bailout fund from buying bonds in secondary markets.

Three-month Euribor rates inched lower on Monday to 0.652 percent from 0.653 percent. That was within range of a record low of 0.634 percent hit in early 2010. Euribor rates were traditionally used as a gauge of interest rate expectations but excess liquidity in the market from two injections of long-term cash from the ECB has made it more difficult to use them as such. Even so, Giansanti said the market was fully pricing in a 25 basis point cut in the refi rate at Thursday's monetary policy."It will give a boost to sentiment, showing that the ECB is committed to doing what is needed to help the economy in the euro area," he added.

Eonia forwards are also showing markets are pricing in a reduction in the deposit facility rate. Eonia rates are seen reaching between 0.24 to 0.19 percent in September - below the deposit facility rate of 0.25 percent, which normally serves as a floor for overnight rates. Eonia rates were last at 0.38 percent. Speculation of a deposit facility rate cut has increased in recent weeks on the back of comments by ECB officials. Two ECB Governing Council members, Austria's Ewald Nowotny and Slovakia's Jozef Makuch, have said they could imagine the deposit rate going to zero. Simon Peck, rate strategist at RBS, said Eonia forwards were discounting an around 9 bps decline in the deposit facility rate in July. Peck expected the rate to be reduced to 0.10 percent or 0.15 percent this week from 0.25 percent currently and the refi rate to be cut by 25 basis points to 0.75 percent, with the possibility of a 50 basis point cut. He too thought the market impact would be more psychological than practical."It's more about signaling. It's a statement, it's the right policy move in the context of the weak data," Peck added.