MONEY MARKETS-Bailout prospects keep Spanish repo rates stable

By Marius Zaharia

LONDON, Oct 11 (Reuters) - The cost of borrowing cash using Spanish government bonds as collateral was little changed on Thursday as the prospect of European Central Bank debt purchases offset 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-investment grade and in line with fellow agency Moody's, which is expected to 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. That is because the price of the bond falls and the value of the collateral is perceived as having depreciated.

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

Also, lending terms in Spanish repo markets rarely go beyond one week as lenders are reluctant to offer cash to banks that have been severely hit by a property bust. Short-term lending rates are less sensitive to the value of collateral than longer-dated rates.

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

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

rose as high as 5.96 percent early in the session as an immediate reaction to the downgrade before pulling back to 5.78 percent, below Wednesday's levels.

A well-bid Italian debt auction also helped increase investors' 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," said Matteo Regesta, rate strategist at BNP Paribas.

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

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

"This is the effect of the 'Draghi' put," said Commerzbank rate strategist Benjamin Schroeder, referring to ECB President Mario Draghi's pledge that the ECB would buy bonds of troubled countries if they seek assistance.

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

(Reporting by Marius Zaharia; Editing by Anthony Barker)

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