August 19, 2014 / 8:25 AM / 3 years ago

RPT-Interbank, Bund rates reach new lows as euro zone outlook dims

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* Overnight Eonia hits new low

* German Bund yields hover just above 1 percent

* Germany expected to auction zero-coupon Schatz

* Russia preps new sanctions as EZ economy stagnates

* Traders see even 50 pct of QE in next year

By John Geddie

LONDON, Aug 19 (Reuters) - Euro zone money market rates fell to new lows on Tuesday and German Bunds held near a record 1 percent yield as the region’s weak recovery and Russian sanctions reinforced expectations the European Central Bank would loosen monetary policy.

The euro overnight lending rate dipped to 0.006 percent, hovering just above zero and an unprecedented drop into negative territory.

“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 Commerzbank.

The ECB decided in June to charge banks to keep their money in overnight deposits, hoping that this would stimulate lending into the real economy.

Strategists say this policy and the amount of spare cash in the banking system are helping to keep rates near zero. Excess liquidity in the system is likely to remain ample after the ECB’s weekly refinancing tender on Tuesday.

Forward money market rates are also at lows, pinned by expectations of a further rise in surplus cash when the ECB starts pumping out new four-year loans from September.

Money market traders now see an even 50 percent chance of an asset-purchase programme, known as quantitative easing, in the coming year, a Reuters poll found on Monday.

The trend is the same for longer-term rates. Strategists expect Germany to announce later on Tuesday that it will sell a new two-year bond on Wednesday with a zero percent coupon.

Yields on German 10-year bonds - the euro zone benchmark - opened at 1.01 percent on Tuesday, after dipping below 1 percent at the end of last week.

Conflict between the Ukrainian government and pro-Russian rebels in the east of the country has led to Russia and the West imposing tit-for-tat economic sanctions.

Those sanctions are tarnishing the outlook for the euro zone, whose economy stagnated in the second quarter. Low inflation is also undermining a fragile recovery.

“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.

Germany’s central bank said on Monday the euro zone economy is expected to grow more slowly during the rest of the year than initially thought. (Editing by Larry King)

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