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Money markets greek tensions risk reigniting dollar funding stress

* ECB's liquidity measures ease dollar funding strains* Uncertainty over Greece could increase stress levels again* Euro rates to remain low on February LTRO prospectsBy Marius ZahariaLONDON, Jan 18 A key measure of dollar funding strains for euro zone banks hit its lowest level in four months on Wednesday on the back of a recent liquidity boost from the European Central Bank but uncertainty over a Greek debt deal risks halting that easing. Debt refinancing worries for euro zone banks eased after they borrowed almost half-a-trillion euros from the European Central Bank late last year and the improvement in sentiment has filtered through to dollar funding markets as well. A cut in the cost of using the dollar swap line that the ECB has opened with the U.S. Federal Reserve has also contributed to the fall in interbank dollar lending rates. The three-month euro/dollar cross currency basis swap , which tightens when lenders charge less for swapping euro interest payments on an underlying asset into dollars, narrowed to minus 82 basis points, a level last seen in mid-September. This compares with minus 167.5 bps hit in late November which was the widest in three years."It's a function of ECB liquidity measures, which are reducing stress in money markets," said Chris Walker, currency strategist at UBS.

However, there are growing tensions around talks between Greece and its private creditors aimed at avoiding a default, and traders warn that could counter the effects of the additional liquidity. The talks resumed on Wednesday. Some banks still find it hard to secure dollar liquidity and had to tap the ECB's one-week dollar tender on Wednesday. Fourteen banks borrowed $5.89 billion in the auction, compared to 15 banks taking $5.72 billion in the previous week."The improvement in the (tighter) euro/dollar basis swaps is just in the price ... The U.S. (dollar) market is still closed for these banks," said ING rate strategist Alessandro Giansanti.

"If no agreement will be reached in Greece and we move closely to a disorderly default I would expect the basis swap to rewiden again."Benchmark three-month dollar interbank Libor rates also inched lower to 0.56120 percent from Tuesday's 0.56230 percent. CASH BONANZA Most of the extra cash the ECB has pumped into the system is returning to the central bank via its deposit facility, meaning that it is not put at work, leaving the interbank markets frozen and the shrinking real economy scarcely financed.

Lenders parked an all-time high of 528 billion euros with the ECB on Wednesday, up from 502 billion the previous day. Changes to the ECB's rules that require banks to keep less of a cash buffer with the central bank enter into force with the start of a new reserve maintenance period on Wednesday and are estimated to leave an extra 100 billion euros in the system. The extra liquidity may end up in the deposit facility as well, unless banks decide to borrow less at the ECB's cash tenders. However, on Tuesday, banks took 127 billion euros in one-week funds, more than expected by traders in a Reuters poll and 16 billion more than the week before. The huge excess of cash in the system is expected to keep overnight Eonia rates within a 35-45 bps range in the next month, analysts say. In Eonia forwards market, Societe Generale strategists see an opportunity to receive February Eonias and pay January, as they consider the 1.5 bps spread between them too small due to plans for another three-year cash injection in February and a "non-zero probability" that the ECB will cut rates next month. But they added that trading opportunities in the Eonia space are few due to the excess cash in the market. There was more value in bets that spreads between forward Euribor rates and forward Eonia would tighten, they said, "given that they have lagged so much relative to peripheral spreads, although the ECB has greatly reduced ... liquidity risks."On the other hand, RBS has recommended earlier this year to bet against the tightening on the view that the ECB's liquidity boost only solved a short-term liquidity problem for banks and not the underlying stress factor in the banking sector, which is the sovereign debt crisis.

Money markets italian downgrade compounds bank funding problems

* Downgrade set to follow for Italy's banks* Some Italian bank debt could near "junk"* Repo funding opportunities disappearBy Kirsten DonovanLONDON, Jan 16 Standard & Poor's decision to strip Italy of its single-A rating means many of the country's banks are likely to see their debt move closer to non-investment grade, compounding their funding problems. Italian banks, shut out of funding markets, are already highly reliant on the European Central Bank for both short- and longer-term funding. S&P on Friday cut Italy two notches to BBB+, three notches above "junk". It is normal for a rating agency to cut a country's banks shortly after downgrading the sovereign."Italy at BBB+ means Italian bank debt will be closer to high yield," said Alberto Gallo, credit strategist at RBS."The biggest short-term risk here is the potential downgrade of subordinated bank debt out of the investment grade benchmarks."

Italian banks' borrowing from the ECB has already risen sharply -- to nearly 210 billion euros in December from 153.2 billion euros at the end of November -- mirroring the take-up of three-year funding at the end of the year which will help meet maturing bond repayments. Indeed, Societe General credit strategist Suki Mann said only "quality" banks in the core euro zone countries have access to longer-term funding markets."I'd be surprised if we see an issue from a peripheral bank for at least 6-months, maybe even longer," he said."There is a non-trivial probability that February's three-year ECB funding operation will not be the last one."

Euro zone banks borrowed almost half a trillion euros of three-year money in December and have another opportunity to take such funding in late February."There will probably be a lot of demand and if things deteriorate again I wouldn't rule out them doing another one," said Commerzbank rate strategist Christoph Rieger."But I wouldn't underestimate the impact of these (operations), they're very important to avoid a full-blown credit crunch."The sovereign rating downgrade also means the country's bonds will not be eligible as collateral when raising funds in parts of the repo market.

Repo clearing house LCH. Clearnet considers the lowest rating allocated by the three major rating agencies when it allocates bonds to its AAA, AA and A-rated general collateral (GC) baskets -- bonds in the basket are eligigle for delivery in exchange for cash for a set period of time. The cost of using a government bond as collateral for funding increases if the bond drops to a lower GC basket, which also means it will cost more to raise funds using French bonds after S&P stripped the country of its triple-A rating."Market repo financing looks set to become more difficult for most issuers, especially for Italy," Commerzbank strategists said. The two clearing houses involved in Italian repo operations also raised their margin requirements on trades using the debt on Friday, increasing the cost of funding for those wanting to borrow specifically against Italian bonds."We need to stop thinking about normal as what it used to be," said SG's Mann."The non-core banks are going to continue to be reliant on the central bank facilities."Another worrying sign is that Italian banks non-bank and non-government deposits fell by 37 billion euros in November, according to JPMorgan, while Spanish deposits fell by 7 billion euros after a 25 billion euro fall in October. Although the declines are relatively small, after Irish bank deposits started to decline, they fell 20 percent in a year, while Greek deposits were 27 percent off their peaks at the end of November, JPMorgan noted.