By Win Thin

If you listen to European officials, the bank stress tests are the greatest thing since sliced bread. Banking analysts say otherwise, and we will be watching for clues in the days ahead that the tests have eased stresses in the European banking sector. Our gut feeling is that they have not, but we look to see how interbank lending rates behave in the coming days, and also how much banks are still going to the ECB for their funding needs.

Recall that EURIBOR rates have been rising steadily since April, due in large part to perceived increases in counter-party risk. As a result, weaker banks from the periphery have been big users of cheap ECB funding as an alternative.

Note that three-month EURIBOR was fixed today at its highest level (.82323%) since July 9. We also note that it was recently reported that Spanish banks boosted ECB borrowing to EUR126.3 billion in June, up almost 50% from EUR85.62 billion in May, while Portuguese bank borrowing rose to a record high EUR40.2 billion in June, up 12% from May.

ECB reported that it bought only EUR176 million of sovereign bonds last week, the lowest since the program began in May. While sovereign spreads have stabilized, they remain quite elevated and are still pricing in significant default risk for Greece.

The euro remains firm, but continues to have trouble with the 1.30 area. Markets are still quite negative on the U.S. economic outlook, and are giving the euro a bit of a bid. Markets are also relieved that stress tests, however flawed, have finally been released.

The 1.30 level is very important, representing the final 62% retracement level of the big April-June selloff in the euro. Break would target the April 12 high around 1.37. The yen and Swiss franc are stronger across the board today, which suggests to us that some risk aversion is lingering.
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