Money markets short term rates edge lower after bank lending data

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* Money supply data shows lending to corporates shrinks* Euribor futures bounce from session lows after the data* Concerns rise about banks' government bond holdingsBy Marius ZahariaLONDON, March 28 Short-term interest rates inched lower on Wednesday after data showed the glut of cash injected by the ECB has yet to find its way through to the real economy, reinforcing bets that monetary policy will remain loose for a long time. The monthly flow of loans to non-financial firms fell by 3 billion euros in February after rising by just 1 billion euros in January. Euribor futures rose by around 3 ticks from session lows across the curve after the data, reflecting expectations for easier monetary conditions going forward. Market participants said the move reflected that markets now expected any ECB exit strategy will be activated later than previously thought rather than increasing bets for an interest rate cut or more liquidity injections.

"The huge amount of liquidity not only in the euro zone, but also in the U.S., UK and Japan means that the level of yields in bond markets is quite low and this is leading the corporate sector to go to the market for funding, (and rely) less on bank lending," BNP Paribas rate strategist Patrick Jacq said."There is no hurry for the ECB to ease or exit."A Reuters poll showed the ECB was expected to keep rates on hold in the foreseeable future. At the same time, data showed Italian and Spanish banks used the cheap loans from the European Central Bank to stock up on domestic government bonds, increasing their dependency on the sovereign's ability to fight the debt crisis.

The new data, which captured the period just before ECB's record second injection of 3-year cash, showed Italian banks increased their holdings of euro zone debt by 23 billion euros, taking their total holdings to 301.6 billion euros. Spanish banks increased their holdings by a hefty 15.7 billion euros. While the rise was smaller than January's record 23 billion, it left total sovereign holdings at a record 245.8 billion euros. JPMorgan estimates the holdings of government bonds as a percentage of total banking assets is now around 8 percent for both Italy and Spain, which is the highest in the euro zone after Greek banks, whose government debt represents 10 percent of total assets.

"It's a big figure ... If at some point we have a reignition of worries about the sovereign, banks will suffer massively," said Nikolaos Panigirtzoglou, European head of global asset allocation and alternative investments at JPMorgan."What destroyed Greek banks was not the fact that their equity was wiped out, was not ... their loan book, it was their government securities."Meanwhile, in a further sign that dollar funding conditions have eased, banks borrowed only $6.25 billion for three-months, compared with $25.5 billion."This reduction in the usage of the ECB's dollar facility is not surprising, given that private markets are more readily providing dollars," said Elaine Lin, rate strategist at Morgan Stanley. The three month euro/dollar cross-currency basis swap , which shows the rate charged when swapping euro rate payments on an underlying asset into dollars, kept close to its tightest since August 2011 at around minus 55 basis points. The measure, which widens in times of funding stress when investors compete for dollars, has gradually tightened from November's minus 167.5, a level not seen since the aftermath of Lehman Brothers' collapse in late 2008.