Euro swaps benchmark fixed at a negative rate

A key money market rate European banks charge to lend to each other and which serves as the reference level for derivatives contracts has fallen into negative territory for the first time, as the European Central Bank stimulus effort intensifies the downward trajectory of eurozone interest rates.

The euro interbank lending rate for three-months - widely known as Euribor - broke new ground when it was fixed at minus 0.001 per cent on Tuesday. That came after the London based euro interest rate fixing for three months entered negative territory for the first time last week.

Short-term money market rates such as Euribor are a key reference level used in the vast interest rate swaps market and also for interest rate futures contracts. Euribor also underpins the cost of consumers' mortgages and what they are paid on savings products. Some strategists believe a decline in savings rates could help stimulate wider demand by making it less attractive to save.

"As it goes further into negative territory it's going to have a psychological impact on people. It will impact the savers' rates and if there is no incentive to save you would rather spend," said Khagendra Gupta, fixed-income analyst at JPMorgan.

The ECB has aggressively eased monetary policy in the hope of stimulating growth and staving off a damaging deflationary spiral. It tested new waters in June 2014 when it introduced a negative deposit rate - meaning banks have to pay to park money at the central bank - which sparked a steady decline in interest rates across the region.

Since the ECB launched its $1.1tn bond-buying programme in March, rates have fallen even further, and that is now pulling key interbank lending rates into negative territory, raising the prospect of distorting financial markets.

"A negative interest rate completely counters the incentive that lenders normally face," said Lena Komileva, chief economist at G+ Economics. "The risk is it distorts markets by distorting the incentive to bring borrowers and lenders together, which markets are there to do.''

She warned: "In some cases, by drying up money market activity in peripheral countries, negative rates may prove contractionary, rather than stimulating."

Some strategists have suggested that with the ECB base rate at minus 20 basis points, banks have little choice, but to take the less negative rate offered by Euribor.

"Because policy rates have been lowered and excess liquidity in the system has been increased, it means banks are willing to lend to each other for less," said Nishay Patel, rates strategist at JPMorgan.

Many traders had been prepared for a move to negative yields.

"The Swiss were the first to go negative. The real money markets people found it difficult to get their heads around negative yields, but it doesn't have much of an effect on the treasury management side of the business. The cash flows work for the asset managers," said one trader.

Additional reporting by Phillip Stafford

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