* Market betting ECB could cut rates by 50 bps by Dec
* Chance of a rate cut on Thursday still evenly split
* Tensions seen in dollar funding
By Emelia Sithole-Matarise
LONDON, Nov 2 (Reuters) - Money markets have moved to price in an outside chance that the European Central Bank could fully reverse this year’s rate hikes by December since Greece shook financial markets with plans to hold a referendum on its latest bailout package.
Market bets the ECB may cut rates after its policy meeting on Thursday remain evenly split even after data on Monday showed euro zone inflation held at 3 percent for a second straight month in October, above the bank’s target of close to 2 percent.
But forward Eonia contracts for December price in a 20 percent probability the ECB will cut its key refinancing rate by 50 basis points to 1 percent. Before the Greek announcement, which stoked fears of a disorderly default, the market was only pricing in a 25 basis point cut.
“There was a sharp repricing for the December meeting since the beginning of this week...and the probability (of a 50 bps rate cut) has increased over the last couple of days,” said Barclays Capital strategist Giuseppe Maraffino.
“We are entering a sharp economic slowdown,inflation should not be a problem because it is expected to go below 2 percent next year and market sentiment has deterioriated over the last two days after the news on the Greek referendum. In this respect further stimulus by the ECB is needed,” he said.
The ECB will meet under new president Mario Draghi and a signal that price risks were to the downside could signal a rate cut in December, analysts said.
Barclays Capital strategists still recommend going long December Eonia on expectations of a rally in the contract if the bank adopts a dovish stance.
Newedge strategist Annalisa Piazza said recent market moves might force Draghi’s hand.
“Given the recent sharp correction in equities driven by the news flow coming from Greece, we suspect Draghi has no choice rather than suggesting that the ECB is ready to act in order to avoid a prolonged recession in the euro area,” she said.
Greece’s unexpected move to put its 130 billion euro rescue deal to a popular vote also added to tensions in dollar funding markets. The cost of swapping euros into dollars as implied by cross-currency basis swaps rose after holding steady following the deal by European leaders to tackle the debt crisis.
The bid rate on three-month cross currency basis swaps widened back below 100 basis points to levels seen in early October before the crisis-fighting plan was agreed.
In another sign that market strains from the euro zone may be broadening, the Bank of Japan offered dollars to banks in market operations on Wednesday for the first time since July last year.
“In these market conditions you have domestic investors in full risk-off mode you could see more widening from here,” said Matteo Regesta, a strategist at BNP Paribas.
“Going into year-end with balance sheet constraints which banks need to face, there’s clearly a scenario where the short term volatility will stay very high.”