Money markets upper hand seen with fed in liquidity tug of war

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A contained fall in euro bank-to-bank lending rates after the European Central Bank promised to keep rates low suggests it may be able to offset only in part the effects of a likely withdrawal of U.S. monetary stimulus. Data on Friday showed U.S. jobs growth was stronger than expected in June, increasing chances the Federal Reserve will start to scale back its money-printing this year. That prompted Euribor futures to fall across the 2015 strip. The ECB's forward guidance - offered for the first time on Thursday - that interest rates will remain at record lows for an extended period and may fall further helped take Euribor rates off highs hit after the Fed indicated it would start to taper. But they have only retraced part of their rise from late May."The reason why the market is looking to the Fed as the dominant force in terms of the current trans-Atlantic liquidity tussle is that the ECB provided us with effectively a passive promise," said Richard McGuire, senior fixed income strategist at Rabobank.

"What they have guaranteed us is, over the near-term, there will not be a rise in interest rates, but that's passive. They told us what they won't do, whereas the Fed has given us an active threat."The ECB's break with its tradition of never pre-committing was a response to market turbulence triggered by the Federal Reserve's plan to exit its quantitative easing programme. Fed Chairman Ben Bernanke said on June 19 the economy was strong enough for the central bank to begin slowing the pace of its stimulus, after flagging that possibility in testimony to Congress on May 22.

Three-month Euribor rates fell to 0.217 percent after the ECB meeting from 0.222 percent - still above the 0.198 percent seen prior to Bernanke's May testimony. Six-month Euribor rates fell to 0.33 percent from 0.34 percent but are still above their 0.293 percent level before the Fed began to hint it would rein in its stimulus.

McGuire said the ECB would probably have to intervene verbally again to counteract the recent Fed-led rise in money market rates. Another interest rate cut may also be needed, taking the ECB's benchmark rate to a new record low, even though analysts say the latter would have a muted impact on growth. Forward-looking Eonia rates suggested investors were not pricing in another rate cut, but had pushed expectations of such a move further out, McGuire added. Overnight Eonia rates were seen reaching around 0.12 percent in December compared to 0.087 percent."There is probably no rate cut priced in here," Commerzbank strategist Benjamin Schroeder said. "It's a reflection that we don't have rate cut speculation at the moment."