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MONEY MARKETS-U.S. commercial paper market shrinks
* U.S. commercial paper market shrinks
* Below-forecast data seen paving way for ECB easing
* Rate cuts or further non-conventional action expected
By Ellen Freilich
NEW YORK, Sept 20 (Reuters) - The amount of seasonally adjusted U.S. commercial paper shrank for a third consecutive week in the week ended Sept. 19, Federal Reserve data showed on Thursday.
U.S. seasonally adjusted commercial paper outstanding fell $7.2 billion to $1.008 trillion in the week.
But U.S. non-seasonally adjusted commercial paper outstanding - which some analysts believe is the more telling figure after seasonally adjusted figures were distorted by the financial crisis - rose $12.2 billion to $984.9 billion.
U.S. non-seasonally adjusted foreign bank commercial paper outstanding fell $3.9 billion to $187.0.
U.S. short-term rates remained low with three-month bills yielding 0.11 percent and six-month bills yielding 0.14 percent. Rates are low because the U.S. Federal Reserve has pledged to keep its overnight federal funds rate near zero through mid-2015.
Euro zone interbank lending rates ground to fresh lows on Thursday as downbeat economic data modestly raised expectations the European Central Bank would cut interest rates or otherwise ease policy again.
Unexpectedly gloomy surveys showed the ECB's aggressive new bond-buying plan has so far failed to inspire any major improvement in business across the region, with the downturn in the service sector accelerating to its fastest pace in more than three years.
"It was weak (data) and increases the probability for the ECB to cut rates in coming months," said Barclays Capital rate strategist Giuseppe Maraffino.
Money market rates, the anchor for borrowing costs throughout the economy, are driven by expectations of central bank monetary policy.
Benchmark three-month Euribor rates have hit new lows almost every day since early July and dropped to 0.233 percent on Thursday.
Euribor rate futures, which reflect expectations of where the three-month Euribor rate will be and incorporate expectations of where the ECB will set its main refinancing rate, rose across the curve after the data was released, pushing implied rates lower .
The December contract ticked up to a new high of 99.82, giving an implied rate of 0.18 percent.
"That is consistent with some probability of a refinancing rate cut," Maraffino said. "But (it) is a reflection of expectations of monetary policy generally...of more easing by the ECB, both in terms of standard and non-standard measures.
Slovakia's central bank governor Jozef Makuch said on Tuesday the ECB had room to cut rates again if warranted, echoing comments by his Belgian counterpart Luc Coene who said both rate cuts and further cheap loans to banks were options.
Barclays expects the ECB to cut its refinancing rate by another 25 basis points to 0.50 percent in the fourth quarter.
BNP Paribas strategists also expect the rate to be cut by 25 basis points -- in December -- and to remain at record lows through 2014. They also look for a cut in the rate the central bank pays other banks to park funds overnight, which would see it fall into negative territory.
By contrast, a Reuters poll shows money market traders do not expect the deposit rate to fall below zero this year , with market pricing based on forward overnight Eonia rates also only showing a slim chance of a cut.
When the ECB cut the deposit rate to zero in July, banks, rather than increasing lending to each other or to the wider economy, merely left their excess funds at the central bank.
Societe Generale's chief European economist James Nixon said the ECB had more effective options at its disposal than a further rate cut -- steps that would more directly tackle the problems faced by the banking sector in Spain and Italy.
"The innovations are going to be designed to address the fragmented nature of the money market and the elevated interest rates in (Spain and Italy)," he said.
"This is no longer a monetary policy problem when we've reached the zero-boundary in rates...if the high rate of deposit withdrawal in Spain continues the banking sector will implode."
Spanish bank deposits fell by around 230 billion euros in the year to the end of July, ECB data shows.
The ECB has so far offered banks unlimited liquidity, bought covered bonds from them and eased reserve and collateral requirements.
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