Overnight rates linked to the ECB's July meeting looked too high following the decision to continue pumping liquidity into banks, analysts said on Monday, despite the central bank signalling its intention to hike rates. The European Central Bank flagged it was ready to raise interest rates in July at last Thursday's policy meeting. Typically that would see markets price the point of next month's ECB meeting on the overnight rate curve at, or slightly above, 1.5 percent.
But the central bank also extended its provision of long term, unlimited funding to banks, which continues to distort the Eonia curve. This means that accurately pricing the path of rate hikes, a process reliant on a predictable spread between interest rates and Eonia, was set to remain difficult in the medium term. Eonia currently dated for the July 7 ECB meeting was last at 1.31 percent, a level which almost fully priced in a 25 bps increase, but this could fall near term, analysts said.
Royal Bank of Scotland strategists said rates linked to July's meeting could fall as far as 1.25 percent. Short-term liquidity conditions, having been squeezed over the last week, looked set to ease at Thursday's regular refinancing operations, supporting predictions of a lower Eonia curve. According to a Reuters poll one-week and one-month tenders would see banks up their borrowing by around 10 billion euro. Exactly when investors thought the central bank would deliver its next rate hike after July was also unclear from market pricing thanks to divergent opinions on how long the ECB would continue providing banking sector support.
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