* Prospect of negative deposit rate still on table
* Market pricing suggest 20-30 pct chance by early 2013
* Lack of clear consensus drives trading strategy
By William James
LONDON, Sept 17 (Reuters) - For euro zone money market traders, one big question is driving prices: will the European Central Bank cut the rate it pays on overnight deposits below zero?
The answer has major implications for funds that specialise in eking out a return through short-term lending while keeping risk at a bare minimum for their investors.
"If you lower the deposit facility below zero it will have an amplified effect on all money market papers -- especially those with higher rating -- and will increase the struggle of funds to provide yield to their investors," said Alessandro Giansanti, strategist at ING in Amsterdam.
But, for investment banks trading in short-term instruments, the uncertainty has generated a potentially profitable pricing discrepancy.
The Eonia lending rate, the price the market pays on overnight loans, is heavily influenced by the deposit rate and current levels suggest modest expectation of a cut.
Citigroup strategists say that based on forward contracts there is a 20 percent chance of a cut priced in by February but highlight that the calculation is far from clear because deposit rates have never before fallen below zero in the currency bloc.
Among factors muddying the waters, a cut to below zero could see correlations used for forecasting break down, the central bank could take unforeseen unorthodox policy steps or liquidity could drain from the market and generate volatility.
Using a different forecasting methodology, JPMorgan strategists see the current probability of a cut at 9 percent for next month, rising to 28 percent for a cut in January, while Barclays Capital say the ECB is unlikely to venture into uncharted waters and do not foresee negative rates.
The lack of consensus is reflected in the wide range of strategies banks are devising to profit from the likely shifts in pricing over the coming months as the ECB lays out its policy.
ECB President Mario Draghi gave little away at his September news conference, prompting bets that would profit from a cut to be pared back, but Governing Council member Ardo Hansson subsequently brought the issue back to the fore, saying the bank should carefully consider the pros and cons of negative deposit rates.
ING's Giansanti said a failure to cut in October would support those who think the ECB will never go below zero. Consequently, current rates of 8.5 basis points on forward contracts between October and December looked too low compared to Eonia fixings around 10 bps.
Conversely, after the recent rise Commerzbank strategists see potential for Eonia rates to fall again and recommend a short-term tactical trade to receive the current interest rate of 5.75 basis points on the March 2013 forward contract
"The re-pricing of the Eonia curve continued to an extent where we now see better chances in receiving Eonia forwards," said Commerzbank's Christoph Rieger.
For Citi, the 1.36 percent rate on a three year Eonia contract with a start date one year from now is an attractive way to play out the uncertainty.
"This trade profits - of course - from a rate cut scenario as well in a situation of long-term unchanged rates, in which the market is desperate to grab the additional yield in forward space," the bank's strategists said in a note.