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Spare cash in euro zone falls below 100 billion euro threshold

A structure showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt July 11, 2012. REUTERS/Alex Domanski

FRANKFURT (Reuters) - Spare cash in the euro zone banking system has fallen below the threshold of 100 billion euros for the first time since the European Central Bank flooded the system with ultra-cheap crisis loans in late 2011.

Excess liquidity, or money banks hold beyond what they need for their day-to-day operations, fell to 92.937 billion euros on Thursday as banks continued to repay some of the crisis loans early.

Economists expect European overnight bank-to-bank borrowing costs to move up once excess liquidity drops below a certain level, seen as between 80 billion and 100 billion euros.

The development is important to watch because an "unwarranted" tightening of short-term money markets is one of the scenarios the ECB has set out that could prompt fresh policy action.

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However, ECB President Mario Draghi has warned that it is very difficult to draw the conclusion that there is a stable relationship between excess liquidity and short-term interest rates.

So far, there is little indication that the ECB will swing into action with medium-term market rates still stable.

G+ Economics chief economist Lena Komileva pointed out that one-year one-year forward rates - the most traded money-market instrument, which shows where one-year contracts are expected to be in a year - were "well within ranges" at 0.2360 percent and no trigger for liquidity easing.

"For a policy reaction function, the decline in excess liquidity itself is not a trigger, but the increase in short term volatility is worth watching," she said, adding that the liquidity decline was mainly driven by banks repaying the long-term crisis funds, which was generally "not a bad thing".

"The stability of medium-term rates suggests that bank deleveraging is working, which makes them less reliant on central bank funding," she said.

(Reporting by Eva Taylor Editing by Jeremy Gaunt)