MONEY MARKETS-Bailout prospects keep Spanish repo rates stable


By Marius Zaharia

LONDON, Oct 11 (Reuters) - The cost of borrowing cash usingSpanish government bonds as collateral was little changed onThursday as the prospect of European Central Bank debt purchasesoffset the impact of a downgrade in Spain's rating.

Standard & Poor's cut the country's rating to BBB-minus,with a negative outlook, just one notch above non-investmentgrade and in line with fellow agency Moody's, which is expectedto conclude its own rating review this month.

Usually, when debt is downgraded, rates in repo markets -where bonds are used as collateral to borrow cash - go up. Thatis because the price of the bond falls and the value of thecollateral is perceived as having depreciated.

However, the likelihood that Spain will eventually ask for abailout kept markets stable. An aid request would activate theEuropean Central Bank's unlimited bond buying programme andprotect the value of the bonds - at least for a while.

Also, lending terms in Spanish repo markets rarely go beyondone week as lenders are reluctant to offer cash to banks thathave been severely hit by a property bust. Short-term lendingrates are less sensitive to the value of collateral thanlonger-dated rates.

"The rates which people are actually lending at have notchanged much, it only brings it in line with Moody's ... and themarket is much more focused on whether they're going to ask fora bailout or not," one repo trader said.

The one-week repo rate for trades using Spanish bonds ascollateral was unchanged at 0.15-0.16 percent, according totraders. In secondary bond markets, 10-year Spanish yields

rose as high as 5.96 percent early in the sessionas an immediate reaction to the downgrade before pulling back to5.78 percent, below Wednesday's levels.

A well-bid Italian debt auction also helped increaseinvestors' appetite to take risks.

"Repo rates didn't move because in the short-term risk(sentiment) is still on and the Italian auction was fine," saidMatteo Regesta, rate strategist at BNP Paribas.

He said a Moody's downgrade may have a stronger impact onthe repo market as it will bring the rating of the bonds into"junk" territory.

If repo rates rise, Spanish banks' dependency on cash fromthe ECB could increase. Data from Bank of Spain showed Spanishbanks borrowed 400 billion euros from the ECB in September, downfrom 412 billion euros in August.

"This is the effect of the 'Draghi' put," said Commerzbankrate strategist Benjamin Schroeder, referring to ECB PresidentMario Draghi's pledge that the ECB would buy bonds of troubledcountries if they seek assistance.

"But when they activate it ... the (availability of bondsas) collateral will actually be getting scarcer," he said,adding that volumes in repo markets would suffer as a result andbanks may have to rely on ECB liquidity even more.

(Reporting by Marius Zaharia; Editing by Anthony Barker)

((marius.zaharia@thomsonreuters.com)(+44)(0)(207 5420950)(Reuters Messaging:marius.zaharia.thomsonreuters.com@reuters.net))