Money markets longer term implied rates up on growth optimism

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Euro zone interest rate futures fell further on Friday , implying higher long-term official rates, but bets the European Central Bank might hike rates at the turn of the year looked overdone as some southern euro zone states face recession. Improved U.S. and German economic data as well as a positive stress test score card from the Federal Reserve for most large U.S. banks spurred bets this week that central banks could start raising interest rates sooner than 2014, as initially expected. The Euribor curve maintained its steepening trend, with the front end of the 2012 strip anchored by the avalanche of cheap ECB cash while 2013-2014 contracts fell five to 11 basis points, anticipating official rates will go up over the longer term. The Eonia strip is now pricing in a marginal probability of an ECB rate hike in December but many in the market say these moves could wane in coming days as they were led more by U.S. data than by a structural shift in the outlook for the euro zone.

"What's going on is basically market players trying to double-guess whether relatively strong data from the U.S. can have an impact on global growth and on the euro economy as well," said BNP Paribas strategist Matteo Regesta."For us the curve steepening is not truly reflective of ECB expectations. We attach a very low, if not zero probability the ECB will raise rates in December. Liquidity is still huge, Italy is in recession, Spain and Portugal are not in good shape."

Barclays Capital also expects the ECB to hold interest rates steady well into 2013, with the abundant liquidity keeping downward pressure on interbank rates in coming months. Three-month Euribor rates, traditionally the main gauge of unsecured interbank euro lending and interest rate expectations, continued to fall on Friday, to 0.853 percent from 0.862 percent - the lowest level since July 2010.

Euribor rates have dropped by more than a third over the last few months on the back of the flood of three-year loans the ECB has injected into the banking system since December. The three-month rates are still well above the low of 0.634 percent they hit in early 2010, indicating there's still room for them to grind lower. Rates in longer-term maturities also dropped. Six-month rates fell to 1.158 percent from 1.168 percent and 12-month rates dropped to 1.495 percent from 1.505 percent. Overnight rates fell to 0.356 percent from 0.363 percent as banks frontloaded funds to meet ECB cash requirements at the start of the new maintenance period."The banking system is still flooded with excess reserves. One-month EONIA swaps around 0.36 percent indicate that money markets are not expecting much change either," Commerzbank strategists said in a note. "If anything, EONIAs have edged slightly higher since last week, implying that average fixings are not seen significantly below 0.35 when looking even further ahead."