Money markets fall in financial stress levels seen short lived

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* Interbank stress measures fall but still elevated* Trader sees value in betting on FRA/OIS spread widening* Eonia forwards pricing in rate cut in March-analystBy Ana Nicolaci da CostaLONDON, Jan 11 Interbank euro zone lending rates fell on Wednesday and were seen remaining low on the back of excess liquidity in the financial system, but, without a resolution to the debt crisis, financial stress measures should resume their rise. The injection in December of nearly half a trillion euros into the financial system, which will be followed by more 3-year loans in February, has taken overnight Eonia rate and interbank Euribor and Libor rates sharply lower. While the abundance of cash has alleviated the immediate threat of a liquidity squeeze among euro zone banks, it has done little to solve the region's underlying problems, analysts say. As a result, banks remain reluctant to lend to each other, depositing a record high amount at the ECB overnight for a fourth session running.. Any flare-up in the crisis would be enough to send measures of counter-party risks higher again, analysts said. The auctions in Spain and Italy, Italy's refinancing needs in the first quarter and Greek debt negotiations were all potential trigger points, said Richard McGuire, rate strategist at Rabobank.

"The concern of a European institution succumbing to a liquidity crunch ... has obviously been much reduced in the wake of the ECB's liquidity provisioning but the concern still remains as regards to the euro crisis more broadly, the ability of peripheral governments to finance themselves, how much of this liquidity will make its way to peripheral coffers," he said."At the moment we are travelling in hope so I wouldn't fight the current tightening of Libor/OIS and an improvement in the broader gamut of risk measures over the near-term. But I equally wouldn't position myself for such because I still see considerable risk that the crisis tensions do flare up at some point in the not too distant future."Euro zone interbank lending rates, or three-month euro Libor rates, fell to 1.19929 percent from 1.20929 percent in the previous session. The spread between three-month euro Libor rates and overnight indexed swap rates -- an indicator of financial stress - was at 85 basis points. That was down one basis point on the day but not very far from 93 bps hit in December -- its highest since March 2009.

The spread between three-month Euribor rates and overnight indexed swap rates stood at 90 basis points in intra-day trade. In December, it hit its highest since February 2009 at around 100 basis points."The spread Euribor-Eonia is still quite elevated, I don't see a big reduction in the spread. So it means that there is still a lot of stress in the market," Alessandro Giansanti, senior rate strategist at ING."To have a robust tightening, we need a solution in the govvie (government bond) crisis. Until we have a solution ... we risk to see a widening again in the spread."

In another sign that some expected stress levels to remain high, one trader said people had kept bets on a widening in the spread between forward rate agreements versus overnight rates , a forward-looking measure of counterparty risk."We don't see any evidence they are taking those off because it is still a positive carry trade and for the investment community it looks like it could be a pretty low, volatile, good carry trade for the coming months," the trader said. "People are still happy to be putting wideners on."Excess liquidity kept Eonia and Euribor rates under pressure, making it increasingly difficult for investors to use these instruments as a gauge of interest rate expectations. But Giansanti said Eonia forward and Euribor markets were fully pricing in a 25 bps rate cut in March. That was in line with a Reuters survey that expects the next rate cut to be in February or March. The ECB announces a rate decision on Thursday but is widely seen keeping them steady at 1.00 percent. Three-month Euribor rates fell to 1.257 percent, the lowest since early April and down from 1.267 percent the previous day. Eonia rates on Tuesday stood at 0.37 percent, not far from the ECB's overnight deposit rate of 0.25 percent.