Europe’s Key Short-Term Funding Rate Falls to All-Time Low

A closely-watched euro-area interbank borrowing rate fell to a record low swelled by all the spare cash sloshing around the economy.

The Euro Short-Term Rate, known as ESTR, slid 0.5 basis points to minus 0.557%, the lowest level since the measure was introduced last year. Attention was already focused on the overnight rate after it hit a technical stumbling block in August. The new low breaks a record set in October.

“This could give a first taste for what may be in store ahead of year-end,” said Christoph Rieger, head of fixed-rate strategy at Commerzbank AG in Frankfurt. “Excess liquidity looks set to hit new records, while banks need to trim down their balance sheets.”

The move comes after banks took more than 1.3 trillion euros ($1.6 trillion) of loans from the European Central Bank in June to meet funding demands after liquidity had all but dried up as financial institutions held on to cash, fearful of the unknown economic impact of the coronavirus pandemic.

These so-called TLTRO loans came with a sweetener that the borrowing rate could be as low as minus 1% if certain lending criteria were met. They swelled the amount of spare cash held by banks to a record 2.91 trillion euros last month.

ESTR is intended to replace the current main benchmark, called Euro Overnight Index Average, or Eonia, as the key reference rate in 2022. The new rate is designed to be less susceptible to manipulation and has been published daily since October.

Month-end patterns may be partly to blame for the drop, said Marco Meijer, senior fixed income strategist at BNP Paribas.

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ESTR’s upcoming status draws attention to any problems with its operation, as funding conditions ease to previously unseen levels in the euro area. Regulators prefer ESTR because its submissions relate more strictly to actual trading, keeping it safer from malpractice but leaving it exposed to any sustained drop in demand for lending among banks flush with cash.

The recenttechnical issue saw the number of reporting banks falling under the minimum threshold of 20, triggering a contingency procedure for the first time, which involved using the previous day’s data to set the rate.

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