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Money markets bank reliance on ecb rises; eu summit eyed

* Bank demand for ECB loans up 4 times on a month ago* Demand seen sturdy for Wednesday's 3-month loansBy Emelia Sithole-Matarise and Marc JonesLONDON/FRANKFURT, June 26 Bank borrowing from the European Central Bank soared on Tuesday, rising more than fourfold since last month in the latest sign that the euro zone's intractable debt crisis is driving up reliance on the ECB's seven-day loans. The rise in demand came as Cyprus became the fifth euro zone state to seek a bailout after Spain - bearing the brunt of the latest debt turmoil - formally applied on Monday to access rescue funds for its struggling banks. Spanish banks faced further pressure after Moody's cut their credit ratings on Monday in a widely expected move after it downgraded the sovereign rating in mid-June. About 180 billion euros was taken up by 105 banks at the ECB's regular offering of seven-day loans on Tuesday, well above expectations and more than four times more than a month ago. The crisis, now in its third year, has choked off bank-to-bank lending.

Only the safest banks in core parts of the bloc are still able to borrow on the open markets, leaving those in Spain, Italy and other countries with outsized debt burdens increasingly reliant on the ECB for their funding. Analysts see little impetus for improved market confidence from a European Union summit later this week, with a quick move towards a banking union or issuance of common euro zone bonds looking increasingly unlikely."In recent months we've moved from dislocated money markets in the euro zone to completely fragmented markets as certain areas have been completely cut off from normal market activity and have become increasingly reliant on the ECB," said Lena Komileva, managing director at G+ Economics.

"The credit downgrades have exacerbated uncertainty about credit risk together with lack of confidence in the ability of EU leaders to find a unified approach of building a banking union."WINDOW DRESSING

This week's demand from banks was higher than the 167 billion euros 101 banks borrowed from the ECB a week ago, well above the 169 billion expected to be taken and far exceeding the 38 billion euros that 84 banks took at the equivalent operation a month ago. Some analysts said the rise could also be due to banks seeking to spruce up their books towards the end of the first half of the year, and were looking to see how much lenders would take up of the ECB's 3-month loans on Wednesday."I would imagine banks would be keen to get some of this longer-term funding on their books," said Simon Smith, chief economist at FxPro. "There maybe some who hold back on the assumption that the ECB may move on rates but... when rates are so low and longer-term ones are done on an average of policy rates over the life of the loan, that effect is marginal."The rising demand for ECB funding is likely to concern the central bank, which has pumped over a trillion euros of 3-year cash into the banking system since the end of December, a move it could have expected to satisfy banks' needs comfortably. It is now lending banks double what it was just six months ago. Reuters calculations show 737 billion euros of excess cash in the euro zone banking system. However, crisis tensions are prompting banks to hoard the money rather than lend it on. Over 750 billion was parked back at the ECB overnight.

Money markets banks prepare for hefty take up of 3 year ecb cash

* Expectations rise for a large 3-year ECB loans take-up* Short-term euro zone rates seen falling further* Euro/USD FX basis could narrow further, M. Stanley saysBy Marius ZahariaLONDON, Jan 25 Shifts in demand at European Central Bank cash tenders this week are pointing towards a large take-up of three-year loans by euro zone banks in February, strengthening the case for lower short-term interest rates in the near term. Investors who are nervous about the risk of a chaotic Greek debt default after another setback in talks on a debt swap deal, are drawing some comfort from the auctions' results, seeing signs that the euro banking system is building up a safety cushion. Banks reduced their intake of three-month ECB funding to 20 billion euros on Wednesday, compared to 45 billion euros they borrowed in October and 35 billion euros in a Reuters poll. On Tuesday, they took 130 billion euros in one-week cash, 10 billion more than expected."This is a shift of the collateral out of the three-month tender and into the one-week tender to have it ready for the three-year," Commerzbank's interest rate strategist Benjamin Schroeder said. A Reuters poll in mid-January showed the ECB is expected to hand out 263 billion euros at its second three-year cash tender in February, but Schroeder said expectations may have risen after Wednesday's drop in demand for three-month loans.

This compares to 489 billion euros taken at the first tender, but JPMorgan strategists estimate a 300 billion euros take-up would be "equally as powerful". They assume that 100 billion euros will be rolled over from existing liquidity operations, 100 billion euros would be used for prefunding maturing bank debt, leaving the other 100 billion euros for carry trades. This is what JPMorgan estimates was the level banks used to buy government bonds after the December three-year tender, halving rates on up to three-year paper in Spain and Italy and driving them lower elsewhere in the euro zone.

Interbank lending rates will also fall further after a take-up of around 300 billion euros as a result of an ever-increasing liquidity surplus in the euro system, analysts say. However, doubts remain that money market functioning would come back to normal. A large chunk of the collateral that could be used in the secured lending markets is going to be stuck with the ECB, while confidence to lend in unsecured markets is unlikely to pick up significantly as long as the sovereign crisis remains unsolved.

DOLLAR FUNDING The better euro liquidity conditions have filtered through dollar funding markets as well. The three-month London interbank Offered Rates (Libor) for dollars fell on Wednesday to 0.55660 percent versus 0.55910 percent in the previous day, having gradually dropped from around 30-month highs at the start of the year. Also, a gauge of dollar funding strains, the three-month euro/dollar cross currency basis swap which usually tightens when dollars are easier to find for euro zone lenders, narrowed below 80 basis points for the first time since August 2011 on Wednesday. Morgan Stanley's head of FX strategy Ian Stannard, who predicted in late December that the basis swap would narrow to 80 bps from three-year wides of 167 bps, said it could tighten further to 60 bps."The amount of liquidity which is now being made available is a big factor in helping to release the tensions in money markets so it is likely to see a gradual narrowing of the basis," Stannard said. He added that the deadlock in talks for the Greek debt swap deal which some traders say has prevented the basis swap from breaking the 80 bps level over the past few sessions will have a limited impact."As long as liquidity conditions remain more favourable which is the case now ... then the impact from the day to day neswsflow coming from Greece will be quite limited," Stannard said.