The ECB signalled on Thursday it would hike interest rates in July but markets proved reluctant to price in any further tightening this year, with negative news on the euro zone periphery keeping investors wary. By using the words "strong vigilance", European Central Bank President Jean-Claude Trichet indicated the ECB would raise its main refinancing rate to 1.50 percent next month to try to contain inflationary pressures.
But, after an initial sell-off, interest rate futures rallied, pushing implied rates lower over the next two years, while expectations for a further rate hike were pushed back to early next year. This was because ECB staff forecasts for 2012 growth, although broadly unchanged, were below some analysts' expectations, while at the same time as Trichet was speaking, Moody's Investors Service said a Greek default would also impact the credit ratings of other bailed-out countries such as Ireland and Portugal.
Traders also said part of the market reaction could be explained by positioning going into the ECB's rate meeting, with the market predominantly short, but Nomura's Maloney said the reaction could be short-lived. The ECB also extended its provision of one-month and three-month unlimited liquidity - a lifeline for banks in the eurozone's debt-laden peripheral countries which have been shut out of the interbank lending market - until early October.
The Eonia overnight rate jumped at Wednesday's fixing, reflecting the lower amount of excess liquidity in the banking system following the smaller take-up at Tuesday's one-week tender. Benchmark sterling Libor rates were unchanged at 0.82438 percent.
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