February 10, 2011 / 2:15 PM / 9 years ago

MONEY MARKETS-UK May rate hike view holds firm after BoE

 * BoE keeps rates on hold, but hike still seen by May 
 * Quarter point hike almost fully priced 
 * In euro zone, Eonia tops one percent as liquidity dwindles
 By Kirsten Donovan 
 LONDON, Feb 10 (Reuters) - Interest rate markets stuck to
their view that the Bank of England would raise interest rates
by Mayafter the BoE held fire on any policy changes on
 Most analysts were expecting the Bank to keep interest rates
on hold at 0.5 percent, although some were pricing in a slim
chance of a hike.
 Speculation of a near term rise has gathered momentum due to
expectations annual inflation will inch up, having already hit
an eight-month high of 3.7 percent in December, almost twice the
central bank's target.
 Minutes of the BOE's January policy meeting also recorded a
more hawkish tone with two members voting for a rate hike and
investors have almost fully priced expectations of a quarter
point move in May.
 March gilt futures and short sterling interest rate futures
fluctuated in the wake of the decision, briefly pushing slightly
higher, before turning tail and trimming their early gains.
 "The fact that short sterling traded a bit lower from where
we were before the meeting suggests today's move was largely
expected and there was a bit of profit taking," said Morgan
Stanley rate strategist Laurence Mutkin. 
 "Now it's all eyes on next week's inflation report." 
 The quarterly update to the BoE's growth and inflation
forecasts are released next week, although the bank's Monetary
Policy Committee will have been privy to the information in it.
 "The report is vital because we are pricing in nearly 100
percent chance of a rise by May's inflation report, so if this
one is remarkably dovish, the market will have to reconsider,"
Mutkin said. 
 Forward overnight swap rates price in only an outside chance
of a move in March, as they had done for this month.
 BoE Governor Mervyn King has predicted inflation could near
5 percent in the coming months but said it remained on track to
return to target early next year.
 "Even if interest rates do rise in the near term, the
likelihood is still that they will rise only gradually and
remain very low compared to past norms," said Howard Archer of
IHS Global Insight, adding that the group saw UK interest rates
rising to only 2.0 percent by the end of 2012.
Benchmark three-month sterling Libor rates GBP3MFSR= were
fixed ahead of the meeting and edged up to 0.80500 percent.
In the euro zone, the Eonia overnight rate EONIA= jumped
above the the European Central Bank's one percent refinancing
rate at the start of the ECB's new maintenance period, after
banks took less liquidity than expected at this week's cash
 Excess money market liquidity has dropped around 60 billion
euros to around 40 billion euros this week after banks scaled
down their intake of one-week and one-month funds on Tuesday
  Despite the ECB dampening speculation of a near-term rise
in official rates by saying last month's larger-than-expected
jump in inflation had not altered its medium-term assessment,
the market is currently pricing in more than 75 basis points by
year-end, according to ING.
 Many said that this seemed overdone at the present time.
 "Certainly, rate increases are coming and the ECB seems
comfortable that the market has now realised that this is the
case," said Societe Generale's European economist James Nixon.
 "However, if inflation is not an urgent and present danger
and activity is slowing, we suspect the ECB would still prefer
to defer rate increases if only to give Europe's banks and
sovereigns more time to sort out their problems."
 Benchmark three-month euro Libor rates EUR3MFSR= were
little changed at 1.048 percent.

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