Money markets market may price out ecb cut after inflation warning

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Short-term euro zone interest rates held steady after the ECB's policy meeting on Thursday but could begin to price out the small probability of it cutting rates this year if Greece's debt swap deal proves successful. The European Central Bank said the bloc's gradual economic recovery might take slightly longer than previously thought and added that inflation might also be more stubborn. For a table of new ECB projections, seeEuribor interest rate futures <0#FEI:> and overnight Eonia rate forwards, instruments usually used to gauge market expectations of moves in ECB benchmark rates, were little changed across the 2012-2013 strip after the comments and analysts said no rate move was priced in for the foreseeable future. Markets have not reacted mostly because they were still nervous ahead of a deadline for investors to swap their Greek bonds for new ones later in the day, a vital exchange for Athens to avoid a chaotic default. But most investors saw that scenario as a marginal risk. A senior Greek government official said on Thursday afternoon that over 75 percent of bondholders with eligible Greek debt had signed up for the bond exchange, meaning the deal is likely to go through. Once that is out of the equation, rates such as Eonia forwards may move higher as analysts leaned towards interpreting ECB President's Mario Draghi's tone at his news conference as somewhat hawkish after his comments on the upside risks for inflation."Money markets have to take it on board that the prospect of a rate cut has gone down over the past hour or so," said David Keeble, global head of fixed income strategy at Credit Agricole.

"Also, they will have to do with the cash that they've got, which is ample."He said fixings of benchmark interbank rates such as Euribor and Libor should continue to grind lower, driven by the bank's injection of around a trillion euros in two rounds of ultra-cheap three-year loans. The three-month euro Libor rate fixed at 0.81429 percent versus Wednesday's 0.82400 percent. The rate has dropped by almost half-a-percentage point this year. Also sensing a slight hawkish bias in Draghi's tone, Societe Generale's head of fixed income strategy Vincent Chaigneau said some of the Eonia forward rates across the 2012 strip might be too low.

"He was probably slightly on the hawkish side ... in particular he upgraded the inflation risks," Chaigneau said. "It would take a better outlook on growth for the curve to steepen, but maybe there's a bit of room in the September Eonia.""0.31 percent is slightly on the low side given that in the February MP (maintenance period) it averaged 0.36 percent. There is still a small probability of a cut priced in ... but the focus now is on the Greek (debt restructuring deal)."Banks are required to keep a certain level of cash with the ECB over the course of a roughly one-month maintenance period.

LIQUID AND CAUTIOUS The ECB has flagged its ample cash injections as a success and said things would have been much worse without the extra funds. But traders say interbank lending activity has not picked up markedly and many remain unconvinced that the worst for the euro zone is now behind."The financial system is incredibly stressed ... you've got to stay ultra cautious, ultra-liquid," said Peter Allwright, head of absolute rates and currency at RWC Partners, which has $4 billion under management. He said the front end of the core European yield curve was going to remain bid as investors remained worried about the risks the euro zone still faced and banks wanted top-quality collateral to secure their liquidity needs."Stay long in the front-end core markets," Allwright said. "It's a good, triple-A, high-quality collateral and there's a massive shortage of that ... I can easily see two-year Schatz yielding negative during the next round of stress."He mentioned poor economic data, high oil prices, the Greek and French elections as future potential crunch points that would increase stress in financial markets.