Money markets more inertia as markets await ecb, greek polls

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* Greek euro exit would make banks even more reluctant to lend* Jump in counterparty risks seen in that scenario* Spanish sovereign, bank CDS are rising sharplyBy Ana Nicolaci da CostaLONDON, May 21 Key measures of counterparty risk have stabilized in recent months and are seen range-bound, with market players looking to the European Central Bank monetary policy meeting in June to see whether it will signal further monetary stimulus. The Greeks also go to the polls next month and if pro-bailout parties do not manage to win a majority that would increase speculation the country would run out of money and that it would eventually be forced out of the euro. The three-month spread between Libor rates and overnight index swap rates - an indicator of financial stress - fell from 55 basis points to around 30 basis points between the beginning of March and early April as sentiment on the euro zone improved. Since then, however, the spread has stopped falling, stabilising at around 30 basis points for the past two months, as the impact of cheap European Central Bank (ECB) financing faded while euro zone tensions resurfaced due to worries about Spain's finances and speculation that Greece may eventually leave the euro. One trader said that if Greece left the euro the LIBOR/OIS spread could immediately jump sharply higher in a knee-jerk reaction. He said spreads could initially rise as far as 60-70 bps and that only the ECB could prevent a further rise in the measure of counterparty risk. In December of last year, the spread rose as far as 93 bps on worries about the euro zone.

"Until the ECB comes in and offers (banks) another long-term (refinancing operation), there is no reason for (spreads) not to blow out," the trader said. The ECB in December and February offered two rounds of cheap 3-year financing which helped ease tensions in both money markets and sovereign debt markets at the beginning of 2012. The excess liquidity helped take Euribor rates to new two-year lows on Monday but concerns over the euro zone's growth prospects, Spain's banking system and Greece's membership of the euro have also helped Euribor/OIS spreads - another measure of counterparty risk - to stabilise in recent months. Analysts are especially concerned about the contagion risks from a Greek exit. Markets may begin speculating other peripheral countries could leave the currency bloc, sending yields on their debt sharply higher and making it more difficult for them to borrow in commercial markets.

"As we have seen already last week, people and companies are withdrawing money from countries at risk of exiting the euro and are moving their deposits to safer countries or even safer currencies," Adam Kurpiel, head of rates derivative strategy at Societe Generale in Paris, said. SPANISH CDS SURGE Worries about a run on Greek banks rattled Athens last week, after savers withdrew at least 700 million euros on Monday alone, according to minutes of President Karolos Papoulias's comments to political leaders posted on the presidency's website.

"Before the ECB steps in to manage the situation, the knee-jerk reaction may be a widening of spreads," Kurpiel added, referring to Libor/OIS and credit default swaps. Societe Generale said in a recent research note that contagion into Italy and Spain would lead to a funding gap of 350 to 700 billion euros, assuming 20-30 percent deposit outflows."A higher probability of a Greek exit means a higher probability of a more generalised run on European banks and of money market paralysis," Kurpiel a d ded. Last Thursday, Spain's Bankia was reported to have seen more than 1 billion euros drained by its customers in the past week, but the Spanish government denied the newspaper report. The country's struggling banking system, along with its deteriorating fiscal position, has been a source of concern for investors who are now demanding more than a 6 percent yield to hold 10-year Spanish debt. Meanwhile, the cost of insuring five-year Spanish debt against default has surged 54 bps over the past month to 556 bps. The credit default swaps on debt issued by Spanish bank BBVA have jumped 59 bps to 491 bps and the equivalent for peer Santander rose 20 bps to 436 bps over the same period."The markets know that if Greece looks likely to be leaving the euro, there will almost certainly be a run in Greek banks and that could see into the other peripheral countries where you could also see bank runs as well. That's probably the main factor (impacting CDS) at the moment," Gavan Nolan, an analyst at Markit said.