Money markets european dlr funding costs cheapest in 15 months

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A barometer of dollar funding risk reached its best levels in more than a year helped by the prospect of European Central Bank intervention but was seen stabilising from current levels. The ECB's promise to buy bonds of struggling euro zone states, as well as expectations the Federal Reserve may soon embark in a third round of quantitative easing, has improved sentiment towards riskier assets generally, underpinning European stock markets and Italian and Spanish sovereign debt. That backdrop has driven the STOXX Europe 600 banking index to its highest in nearly 6 months, reduced the perceived risk attached to owning debt issued by certain European banks and made it less costly for euro zone banks to access dollar funding. The three-month euro/dollar currency basis swap , which shows the rate charged when swapping euro interest payments on an underlying asset into dollars, was at its tightest since June 2011."That is a proxy of European risk appetite and the narrowing in basis is a reflection of decreased tail risks following the ECB's new support measures " Simon Peck, rate strategist at RBS said.

"Today we have seen three-month euro/dollar cross currency basis move a further two basis points tighter as we have successfully navigated the German constitutional court vote on the legality of the ESM and ... another tail risk."Spanish and Italian bonds rallied and German debt prices fell on Wednesday after Germany's top court gave the green light to the euro zone's new bailout fund, prompting relief the bloc's rescue plans remained on track.. The three-month euro/dollar currency basis swap narrowed to minus 25 basis points from minus 27 bps the day prior, having reached minus 160 bps in November last year when the euro zone debt crisis escalated.

RBS's Peck said there was limited scope for further tightening."The narrow levels at the moment are really (based) on happy outcomes for the likes of Spain and Greece but there remain very sizeable risks that we will not see such good outcomes," Ciaran O'Hagan, strategist at Societe Generale said.

Analysts say intervention will not provide a quick fix and some flag the inherent contradictions in the ECB's strategy. For the central bank to intervene in the market, countries have to ask for a bailout first. But for Spain to seek financial help, it would have to be losing access to financial markets, meaning its borrowing costs would have to be at prohibitive levels, analysts say. Spain's Prime Minister Mariano Rajoy suggested as much when he earlier said his government continues to study the price of seeking assistance but improved market conditions may make aid unnecessary. The one-year euro/dollar currency basis swap was also at its narrowest since July 2011 at minus 29 bps, but one money market trader said he expected it to stabilise at around -25 bps given potential risks ahead."The whole feel-good factor has come back to markets," the trader said. "How long it will last, I am not 100 percent sure."