FRANKFURT – Banks will pay back only another 3.5 billion euros ($4.8 billion) of emergency three-year loans from the European Central Bank in a second repayment window next week, suggesting a whopping 137 billion handed back this week was a one-off show of strength.
Financial markets were shocked by the scale of last week's repayment, which slashed the amount of cash floating around the euro zone's banking system and encouraged hope that the region's lenders are in better shape than some had feared.
The resulting boost in confidence has driven the euro to 14-month highs, and the lack of a second substantial repayment to on Friday trimmed those gains only slightly.
"It's fair to say that banks put on a good show last week, surprising the market with the volume of cash handed back to the ECB, but this was likely a one-off," Icap strategist Chris Clark said.
"The road back to normalization of euro money markets will be a very long and slow one."
The figure did disappoint on consensus forecasts for around 20 billion euros in repayments and forward EONIA rates edged lower in response while Euribor futures erased losses and turned positive.
But the euro fell just slightly to $1.3640 from $1.3667 before stabilizing, still well up on the day and just off 14-month highs to the dollar.
The early return of some of the 3-year funds the ECB pumped into the system in late 2011 and early 2012 to avert a credit crunch marks the beginning of an unwinding of the crisis measures taken by the ECB of the past four years - the opposite of action being taken by other central banks.
The ECB's balance sheet is likely to have shrunk to around 2.8 trillion euros as a result, the lowest level since February 2012 just before the second 3-year loan offering. Overall the excess of euros washing round the euro zone's banking system has fallen by around 140 billion euros.
That all effectively adds up to a tightening of monetary conditions at a time when the euro zone economy is showing its first feeble signs of stabilizing, prompting some economists to muse about the chances of a cut in official ECB interest rates to offset any damage to growth prospects.
"Monetary conditions are likely to be a major concern at the ECB, and by that irony the ECB may be closer to a rate cut now than in December and January," Nordea economist Anders Svendsen wrote in a note ahead of the announcement of the loan repayments on Friday, though this was not yet his baseline scenario.
The ECB is set to discuss interest rates at its next Governing Council meeting on Thursday and has been widely expected to leave rates at a record low of 0.75 percent.
Banks took more than 1 trillion euros in total in the two offerings of 3-year loans in December 2011 and February 2012. They can begin to repay funds early on a weekly basis from January 30 for the first tranche and from February 27 for the second. ($1 = 0.7301 euros)
(Reporting by Eva Kuehnen)