November 27, 2012 / 5:16 PM / in 5 years

MONEY MARKETS-Still pricing in chance of ECB deposit rate cut

LONDON, Nov 27 (Reuters) - Money markets are still pricing in some chance that the European Central Bank will cut deposit rates into negative territory, even though that possibility did not feature at its last rate-setting meeting.

But ECB President Mario Draghi also said on Nov. 8 the euro zone economy shows little sign of recovering before the end of the year, leaving open the possibility of an interest rate cut in the months ahead.

Excess liquidity in the financial system and the ECB’s non-standard measures have made it hard to use money market instruments as a gauge of interest rate bets, analysts say.

But the fact that overnight Eonia rates are currently at 7 basis points - offering a spread over the deposit rate at zero - and the fact that Eonia forwards suggest they could fall to around 3 basis points in March next year shows that possibility still exists, analysts say.

“There is some probability priced in the forward on the Eonia that the deposit facility could be cut. This explains why Eonia is seen below the current level,” said Giuseppe Maraffino, a fixed-income strategist at Barclays.

Key Euribor bank-to-bank lending rates steadied, finding a firmer floor as a year-long downtrend under the weight of excess liquidity in money markets fades.

Three-month Euribor rates, traditionally the main gauge of unsecured bank-to-bank lending, were unchanged at 0.189 percent.

Barclays expects the three-month Euribor rate to stabilize around this level. But it says the risks are skewed to the downside, “as rising expectations of a possible drop of the deposit rate into negative territory should push EONIA rates down, thus creating room for a further decline in the Euribor.”

Banks demand a bigger premium to lend to each other over three months than overnight to compensate for the greater risk attached to lending for a longer time.

Benjamin Schroeder, a strategist at Commerzbank, says the bank does not see a deposit rate cut on the horizon but also would not bet against a further fall in the Eonia rates.

“We wouldn’t now start engaging in receiver positions here - betting on higher Eonia rates in the near term,” he said.

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