* Hopes high ECB will restart bond buying this week* Only limited relief seen from such a move* Market prices in 50 pct chance of rate cut by year-endBy Kirsten DonovanLONDON, July 31 Markets are pricing in around a 50 percent chance that the European Central Bank will cut interest rates again this year but are likely to react badly if they have to wait longer than a couple of days for it to revive its bond-buying programme. ECB President Mario Draghi said last week the ECB would do "whatever it takes", spurring expectations that the central bank will reactivate the Securities Market Programme (SMP) at Thursday's policy meeting. The SMP - which the Bundesbank opposes - has been dormant for months but would be used to buy Spanish and Italian bonds in the secondary market. The prospect of this has pushed yields on bonds issued by the two struggling countries sharply lower, but the rally is showing signs of running out of steam.
"Some of the confidence generated by Draghi is already fading - you can see that in the fall in Bund yields today," said BNP Paribas rate strategist Matteo Regesta."To make sure the relief rally we've seen is not further interrupted, at the very least we need a reactivation of the SMP. An interest rate cut by itself would fall short of what the market is expecting. Money markets aren't expecting a cut in either of the ECB's two main interest rates this week, or the "bazooka" option of granting the euro zone's rescue fund a banking license, allow it to exchange bonds it buys for fresh cash from the ECB. The main refinancing rate is at 0.50 percent, while the deposit rate paid to banks who park cash overnight is at zero. A cut in the deposit rate is increasingly priced in from September onwards, which would mean it would turn negative.
"Speculation may be overdone," said Commerzbank rate strategist Benjamin Schroeder."There are complications with negative rates but with the comments from the ECB members, the speculation could still run further."The overnight Eonia rate, which is currently around 10 basis points above the deposit rate, is indicated at around 2 basis points by year-end, suggesting a deposit rate of around minus 10 basis points.
PROMISES Financial markets are looking for a clear policy response from Draghi at the ECB's Thursday policy meeting . Nineteen of 24 euro money market traders polled by Reuters said the ECB will soon resume bond buying."The bar has been raised very high for the ECB to deliver something," Schroeder said. But analysts said even another round of bond buying would be unlikely to stabilise markets in the longer term, although it might ease the next few weeks combined with a sharp drop in new bond issuance over the summer period."It won't offer lasting relief, but it would allow August to be relatively stable," BNP Paribas' Regesta said."The real bazooka, even without activation, would be to grant the (euro zone rescue fund) a banking license... Just the presence of this vehicle with unlimited firepower would bring some peace to primary and secondary markets but we're not going to get that this week."
* US bill rates pushed down by Fed stimulus program * Three-month Euribor rate rises for first time in 3 months * European money markets give up on the idea of deposit rate cut By Chris Reese and Marius Zaharia NEW YORK/LONDON, Oct 1 The U.S. Treasury on Monday sold $32 billion of three-month bills at the lowest interest rate since June, as a Federal Reserve stimulus program put some downward pressure on shorter-dated rates. The Treasury sold the three-month bills at a high rate of 0.085 percent, down from a high rate of 0.11 percent at a similar sale last week and the lowest since a three-month bill sale on June 11. One of the Fed's stimulus program, nicknamed "Operation Twist" because the central bank is selling shorter-dated Treasuries to buy longer-dated Treasuries, was seen as dragging on shorter-dated rates. "Data on primary dealer bond positions show that their holdings of Treasuries have climbed since the start of Operation Twist last October," said Alex Roever, short-term rates strategist at J. P. Morgan Securities in New York, adding "of that increase, 75 percent were concentrated in coupons maturing in three years or less." "With the Fed extending Operation Twist to the end of this year, dealers continue to be cluttered with short Treasuries," Roever said. A Treasury auction of $28 billion of six-month bills on Monday brought a high rate of 0.135 percent, down from a high rate of 0.14 percent in a similar sale last week but up from a high rate of 0.13 percent in an auction two weeks ago. Meanwhile in Europe, key Euribor interbank lending rates rose on Monday for the first time in three months as expectations that the European Central Bank could cut interest rates this week are fading. Money markets are also in the process of pricing out the possibility that the deposit facility rate will ever be cut into negative territory from the current zero percent. Only a minor chance of such a move is factored in for the start of next year, but some banks are recommending clients to exit such bets or position for a rise in January-dated rates. Economists polled by Reuters expect the ECB to leave its main refinancing rate flat at 0.75 percent at its meeting on Thursday. The three-month Euribor rate, traditionally the main gauge of unsecured bank-to-bank lending, rose to 0.223 percent from 0.220 percent. "This points to more uncertainty creeping into the market with regards to any future rate cuts," said Elwin de Groot, senior market economist at Rabobank in Utrecht, the Netherlands. "Rates are very low already and there's basically only one thing that could push down money market rates even further, and that would be a cut in the deposit rate. But that seems not to be a subject of discussion within the ECB." ECB Executive Board Member Benoit Coeure said last week that a cut in the deposit rate, a move that would effectively charge banks to hold money with the ECB overnight, may not be beneficial for all segments of the market. Imposing a penalty for parking cash at the central bank could shake things up in the dormant euro zone money markets and sway banks to take the risk of lending to each other more to get a return on their cash. Healing money market segments that have been frozen by the euro zone debt crisis is seen as an important step towards restoring sustainable economic growth in the region. However, the low level of short-term rates is already making some asset managers take cash out of money markets and put it in other assets such as bonds. The forward Eonia market, showing where investors expect the overnight Eonia rate to be at certain points in the future, is completely dismissing the probability of a deposit rate cut in October. The Eonia rate dated for the October meeting last traded at 0.09 percent. Eonia has fixed at an average of around 8 basis points over the deposit rate in the past few months.