May 2, 2013 / 2:50 PM / 4 years ago

MONEY MARKETS-Short-term euro rates fall on deposit rate cut bets

LONDON, May 2 (Reuters) - Short-term euro money market rates fell on Thursday after European Central Bank President Mario Draghi said the bank was ready for a move to a negative deposit rate.

Draghi said the ECB was "technically" ready to cut the rate it charges banks to keep cash at the central bank overnight to below zero - a move that would effectively penalise them for hoarding cash and not lending it to other banks or businesses.

He said several unintended consequences of such a move were possible, but the ECB would cope with them if it decides to act.

Euribor futures rose 3-5 ticks across the 2013 and 2014 strips, indicating expectations that the benchmark bank-to-bank three-month Euribor rate - a gauge of expectations of future official interest rates and liquidity conditions - will settle at lower levels than initially thought over the period.

"We definitely seem to be a lot closer to going negative than markets initially thought," said David Keeble, global head of fixed income strategy at Credit Agricole.

"His (deposit rate) comments definitely set the cat among the pigeons. He was quite aggressive and had a very dovish sounding tone."

Keeble did not expect Euribor futures to rise much further, saying markets were likely to wait for the next inflation data before gauging whether and when the ECB could make such a move.

OCTOBER/NOVEMBER

Forward euro overnight Eonia rates dated for future ECB meetings dropped by up to 3 basis points across the same strips, with the lowest point on the curve oscillating between October and November at around 0.03-0.04 percent.

Eonia rates have traded about 8 bps above the deposit rate in recent months, meaning money markets are pricing in a slight chance of a deposit rate cut in October/November.

"That makes sense. The ECB still expects a recovery in the second half ... and if we don't see any signs of that by autumn we could see a move in the deposit rate," said Anders Svendsen, chief analyst at Nordea in Copenhagen.

Draghi's mention of unintended consequences also suggested the ECB was unlikely to cut the deposit facility rate - effectively a floor under money market rates - any time soon.

Low money market rates may reduce banks' incentive to lend to each other. Some U.S. money market funds restricted lending to European banks last year when talk first emerged about the possibility of a deposit rate cut.

"I guess the ECB is still afraid of draining the money market completely. It's worried about money market funds and potentially about taxing the banking system, which is one way of looking at (a deposit rate cut)," Svendsen said.

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