Article 8.7 Eurozone borrowing costs hit record low
By Christopher Thompson and Elaine Moore
Financial Times August 12, 2014
Benchmark overnight borrowing costs in the eurozone have tumbled to a record low of 0.01% amid worries that Europe's fragile economic recovery is stagnating.
The move follows a package of measures the European Central Bank announced in June to further flood the market with liquidity.
‘A low Eonia, along with expectations of further liquidity to come from the ECB, keeps other money market rates low,' said Giuseppe Maraffino at Barclays. The ECB said it would begin charging banks for parking their funds.
But data released last week showed Italy has now slipped back into recession, while manufacturing figures in Germany were below expectations, fuelling hopes among some investors that the ECB will do even more to calm febrile markets.
‘Given the clear weakening of European economic activity in the past few weeks there is hope that the ECB will have to do even more, such as buying asset-backed securities or other purchases that would inject further liquidity into the system,' said Vincent Chaigneau at Societe Generale.
Yields for two-year German Bunds are now below zero, meaning investors in effect are paying for the security they receive in short-term German government debt.
This decline has been matched by a fall in yields on Berlin's benchmark 10-year debt, which are fast approaching 1%.
‘There has been a flight to quality but it has not led to the typical rebalancing of portfolios away from risky periphery debt,' said Gianluca Salford, at JPMorgan. ‘That's because this is about investors betting that the ECB will not be able to increase interest rates for years to come.'
FT
Source: Thompson, C. and Moore, E. (2014) Eurozone borrowing costs hit record low, Financial Times, 12 August.
© The Financial Times 2014
Tibor, Sibor and Hibor
Many other countries have markets setting rates for lending between domestic banks.
Tibor (Tokyo Interbank Offered Rate) is the rate at which Japanese banks lend to each other inJapan. In Singapore there is Sibor and in Hong Kong there is Hibor.Federal funds rate and prime rate
In the US, the equivalent to very short-term Libor or Eonia is the Federal funds rate (Fed funds). This is the daily effective rate at which depository institutions lend balances to each other overnight, calculated by the Federal Reserve Bank of New York as a volume-weighted average of rates on brokered trades. This is strongly influenced by the US central bank, the Federal Reserve, which sets a target rate and then can influence the Fed funds rate by increasing or lowering the level of cash or near cash reserves the banks have to hold. Banks often need to borrow from other banks to maintain the required minimum level of reserves at the Federal Reserve. The lending banks are happy to lend because they receive a rate of interest and the money is released the next day (usually). This borrowing is unsecured and so is available only to the most creditworthy.
Fed funds interest rate - borrowing in the US - and the overnight US dollar Libor rate - borrowing in the UK - are usually very close to each other because they are near-perfect substitutes. If they were not close then a bank could make a profit borrowing in one overnight market and depositing the money in another. If the US dollar Libor rate is significantly higher, banks needing to borrow will tend to do so in the Fed funds market and the increased demand will push up interest rates here, while the absence of demand will encourage lower rates in the US dollar Libor market. Having said that, they are not perfect substitutes: the Fed funds rate tends to be slightly lower than US dollar Libor because of the greater safety in the US with the Federal Reserve overseeing and backing up the debt market, including deposit insurance. Thus the arbitrage opportunity is really about the risk premium in London over the Fed funds rate, but the risk premium is usually pretty small.
The Federal Reserve created vast amounts of new money by buying about $3 trillion of bonds over the five years to 2014. It funded this by creating bank reserves. Now that banks have plenty of reserves, interbank lending has reduced dramatically. This has distorted the Fed funds rate and interrupted the normal mechanism for adjusting interest rates through central bank intervention (discussed further in Chapter 16). Article 8.8 considers the possibility of using other measures of short-term dollar borrowing as benchmarks.