Money funds soothed by lack of fed rate cut talk

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Money market fund managers breathed a sigh of relief on Wednesday after minutes from the Federal Reserve's June policy meeting showed no indications the central bank was considering cutting the interest rate it pays on excess reserves to banks. Many fund managers believe any cut in the rate, which currently stands at 0.25 percent, would cause disruptions in funding markets, especially money market funds. Minutes from the Fed's June meeting, released on Wednesday, showed the central bank was open to the possibility of buying more bonds to stimulate the economy, although the recovery might need to weaken for a consensus to build. The minutes did not include any discussion of a possible cut in interest rates the Fed pays on excess reserves on banks. Such a cut has been posited as an economic stimulus option for the central bank, as it would then be less profitable for banks to leave their excess reserves with the Fed, and might encourage banks to make more loans and invest in higher-yielding securities. But some analysts believe any cut in the interest rate would hurt money market funds.

"Money funds are prohibited from buying assets with negative yields. So what would they buy if interest on excess reserves was lowered and caused all market rates to move to zero percent or less?" asked Joseph Abate, money market strategist at Barclays Capital in New York, adding "they would have to close shop."Meanwhile, in Europe, euro-zone bank-to-bank lending rates hit new all-time lows on Wednesday, as the European Central Bank's move to cut its main refinancing and deposit rates to historic lows weighed on market rates. The ECB's overnight deposit rate, which it cut to zero on Thursday, acts as a floor for money market rates as banks only lend to rival banks if they are able to earn a better rate of interest than at the ECB.

The ECB hopes its unprecedented move, which means banks will now get nothing if they park their spare cash with the central bank, will boost interbank lending by forcing banks to look for more profitable options. Although some money market experts fear the cut could backfire and kill off parts of the market, the move has had an immediate impact on bank-to-bank rates. Three-month Euribor rates, traditionally the main gauge of bank-to-bank lending, on Wednesday hit a new all-time low of 0.512 percent, down from 0.521 percent.

Other key rates saw similar drops. Six-month Euribor rates fell to 0.795 percent from 0.805 percent and shorter-term one-week rates decreased to 0.145 percent 0.158 percent. Overnight rates which do not yet factor in the benefit of the ECB's cut - coming into force overnight Wednesday - inched down to 0.323 percent from 0.325 percent. Euribor rates are caught up in a manipulation scandal centered on the counterpart Libor bank-to-bank rates, after it emerged a number of banks were falsely submitting the rates they pay to the committee that aggregates the data. Dollar-priced three-month bank-to-bank Euribor lending rates also fell on Wednesday, dropping to 0.97571 percent from 0.978 percent, with overnight rates falling to 0.34286 percent from 0.346 percent. Euribor rates are well above the euro-priced Libor rates, one reason being that Euribor figures include prices from more of Europe's struggling banks than Libor.