Money markets ecb rate cut bets pared, still on the table

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* Short-term rates inch higher after Draghi speech* Markets still discounting ECB rate cuts in 2012* Bets may pile up again if Spanish, Greek worries remainBy Marius ZahariaLONDON, June 6 Short-term euro zone interest rates rose slightly on Wednesday after the European Central Bank failed to flag it was ready to ease monetary policy, but markets are still pricing in a large probability the bank will cut rates later this year. The ECB kept its refinancing rate unchanged at a record low of 1 percent and the deposit facility at 0.25 percent and President Mario Draghi warned his bank cannot make up for other institutions' lack of action. This disappointed markets, which had expected him to at least send out a signal that more easing was forthcoming."From the tone of it, as of today we cannot expect any significant measure in July because he looked very defiant and imperturbable - the ball is very much in the court of the politicians," BNP Paribas rate strategist Matteo Regesta said. However, rate cut bets have not been taken off completely.

Regesta estimated that the forward overnight euro zone interbank EONIA rate markets - which moved 1-3 basis points higher across the 2012 curve after Draghi's speech - was still pricing in 24 percent probability that the deposit facility rate will be slashed in half in July. For the end of the year, a December EONIA of just over 23 basis points discounted a 66 percent probability of that happening, compared to some 80 percent at the end of last week. Euribor futures also sold off a few ticks after Draghi's speech, implying expectations for higher fixings of three-month Euribor rates in the future. The December Euribor contact was 3 ticks lower on the day and also compared with levels seen earlier in the session at 99.43, implying a 0.57 percent Euribor fixing in the last month of the year versus Wednesday's 0.663 percent.

After May's ECB meeting, which also disappointed markets waiting for more central bank easing, the December contract sold off to as low as 99.29, but it was bought back in the past few days as rate cut bets have been put back on the table. Analysts say the same thing could happen next month if the conditions that led to speculation the ECB could cut interest rates on Wednesday are still in place. Tensions over Spain's stricken banking sector are rising and the risk that Greece could leave the euro zone after its June 17 election is perceived as high. This is hampering business sentiment and growth potential even in the euro zone's powerhouse Germany, as shown by recent data, strengthening the case for the ECB to act."(A rise in ECB easing bets) could happen again, it depends on developments in Spain - if they get help, how large recapitalisation needs for the banking system are," said Commerzbank rate strategist Benjamin Schroeder.

"Also there is no clear indication what the outcome (of the Greek election) would be.""VERY DYSFUNCTIONAL" Moody's cut the credit ratings of six German banking groups and Austria's three largest banks on Wednesday, giving a glimpse of how far the ramifications of a potential Greek exit from the euro zone might go. Banks more than tripled their uptake of ECB dollar funding on Wednesday, the latest indication that some are finding it increasingly hard to source cash in the market. Traders say three weeks is the longest period for which most banks are willing to lend in cash markets, and that's only to a select group of counterparties, also because they are dressing their books for the half-year turn. In his post-meeting remarks, Draghi himself described interbank markets as "very dysfunctional".