* Overnight Eonia hits low, Bund yields dip back below 1 pct
* Russia preps new sanctions as euro zone economy stagnates
* Traders see 50 pct of QE in next year
* Portugal yields fall as Fitch praises court ruling
(Updates prices, adds new comments, data)
By John Geddie and Marius Zaharia
LONDON, Aug 19 Euro zone money market rates fell
to new lows on Tuesday and German Bund yields dropped below 1
percent as the region's weak recovery kept up pressure on the
European Central Bank to maintain its ultra-loose monetary
With a new tit-for-tat sanctions between Russia and the West
being discussed as the Ukraine conflict rumbles
on, investors are growing increasingly certain that subdued
growth and inflation will herald a prolonged period of low
Money market traders now see an even 50 percent chance of an
ECB asset-purchase programme, known as quantitative easing, in
the coming year, a Reuters poll found on Monday. A previous
survey showed only a one-in-three chance.
While investors see a long period of low price growth ahead,
they expect the ECB to prevent the euro zone economy to fall
into a Japan-like deflationary spiral.
"We are not willing to bet against the ECB doing whatever is
necessary to avoid Japanese-style policy mistakes," said Michael
Krautzberger, head of European fixed income at BlackRock.
Yields on German 10-year Bunds - the benchmark for euro zone
borrowing costs - fell back below 1 percent on Tuesday. They hit
a record low of 0.952 percent last week.
The euro bank-to-bank overnight lending rate
settled at a record low of 0.006 percent on Monday, helped by
ample spare cash in the euro zone's banking system, which
currently stands at 134 billion euros.
The ECB cut all its interest rates in June and made new
four-year loans (TLTROs) available to euro zone banks from
September. It also injected liquidity into money markets by
abandoning a tender to sterilise crisis loans.
But strategists say current market prices are starting to
price in further policy easing ahead.
"Low rates are simply an expectation of continued ample
liquidity from the ECB, certainly through the TLTROs but maybe
down the line through additional initiatives," said Lars Peter
Lilleore, chief strategist at Nordea.
Forward money market rates are also at historic lows, pinned
by September's cash injection. Looking further out, Nordea's
Lilleore said rates for 2015 suggest there will have to be
negative daily fixings.
"I wouldn't exclude the overnight rate dropping below zero,
but I find it difficult to see banks charging negative rates on
unsecured lending," said Benjamin Schroeder, a strategist at
The ECB's preferred measure of the market's medium- to
long-term inflation expectations shows that investors see price
growth eventually hitting the ECB's target.
The five-year, five-year forward breakeven rate, which
measures roughly where investors see five-year inflation rates
in five years' time, stands around 2 percent.
But other measures are falling sharply.
Two-year breakeven rates, which measure inflation
expectations by showing the difference between yields on
inflation-linked and nominal bonds, were last minus 0.3 percent,
having been positive a month ago.
"What has really driven the market here is poor
macroeconomic data, probably compounded by the sanctions and the
implication that this might have on economic activity," said
RBC's head of European rates strategy, Peter Schaffrik.
Elsewhere on Tuesday, Portugal's 10-year yields
dropped 9 bps to 3.42 percent. Ratings agency
Fitch said partial approval by the country's constitutional
court of expenditure measures reduced a key near-term risk and
kept the country on track to hit fiscal targets.
(Editing by Alison Williams)