ECB rate rise in 2021? Markets starting to think about it

LONDON (Reuters) - Money markets are starting to price higher interest rates for the euro zone next year, reflecting belief the economy is past its worst and the European Central Bank is wary of further monetary easing.

FILE PHOTO: A man walks towards the European Central Bank (ECB) headquarters in Frankfurt, Germany, July 25, 2019. REUTERS/Ralph Orlowski/File Photo

Early last year, money markets had bet on the ECB raising interest rates in 2020. But worsening economic indicators and the U.S.-China trade war forced investors to position for rate cuts instead. Indeed, the ECB cut rates to a record low -0.5% in September and resumed asset buying to counter the downturn.

Since then, expectations for more cuts have dwindled; Eonia and Euribor interest rate futures suggest markets are again positioning for tightening in 2021.

(Graphic: Euro zone money market curve steepens click, )

Three-month Euribor, the rate at which banks borrow from the unsecured market, is at -0.39%. Embedding market expectations of where three-month money will trade, the contracts are effectively a gauge of where central bank rates are headed.

Euribor rates hold around -0.39 until March 2021, then rise to -0.37%, implying expectations for higher rates are starting to be factored in.

Antoine Bouvet, senior rates strategist at ING, noted one-year Eonia futures dated from January 2021 and a steeper Eonia money market forwards curve paint a similar picture.

(Graphic: Citi's euro zone economic surprise index click, )

“There has been a notable hawkish shift in expectations in December,” he said.

“The communication vacuum, change in management, and (upcoming) policy review leave room for markets to anticipate a more hawkish ECB,” Bouvet said, referring to ECB divisions over resuming stimulus and a push for a more consensual approach under new chief Christine Lagarde.

The shift in expectations follows easing recession risks and improving data -- Citi’s euro zone economic surprise index is near its highest level in almost two years.

Some reckon the ECB could edge towards ending its negative interest rate experiment. Sweden recently became the first central bank to lift sub-zero borrowing costs back to 0%, the level long considered the floor for rates.

“The move in Sweden shows it is possible to exit negative rates,” said Christoph Rieger, head of rates at Commerzbank. “There’s some speculation the ECB could heed this lesson and normalise rates after this year.”

Reporting by Dhara Ranasinghe; editing by Sujata Rao and Larry King