* Rate cut bets remain despite EU summit outcome
* Expectations based on deteriorating economy
* Cut seen improving sentiment more than economy
By Ana Nicolaci da Costa
LONDON, July 2 (Reuters) - Money markets expect the European Central Bank to cut interest rates this week as the euro zone economy struggles, with policy action at the European Union summit having provided only fleeting relief to volatile sovereign debt markets.
Forty-eight of 71 analysts expect the ECB will trim interest rates on Thursday, with most predicting a 25 basis point cut to 0.75 percent, where they will stay until 2014 at least. .
The survey was taken before European leaders decided on a more flexible use of euro zone rescue fund last week, but given recent economic data and rhetoric from ECB policymakers, analysts are still betting on more monetary easing.
Joblessness in the euro zone rose to a record high in May and lending to European firms contracted that same month, piling further pressure on the central bank to act.
“What has come out from the (summit) meeting can be a positive first step but is not conclusive or what is needed to tackle the crisis and tensions in the interbank market. So I expect ECB action, even if we are not sure that it will be so effective for the economy given that rates are already very low,” Alessandro Giansanti, senior rate strategist at ING said. European leaders decided last week that euro zone rescue funds could be used to stabilise bond markets without extra austerity measures and recapitalise banks directly without increasing the country’s budget deficit.
The outcome gave some relief to sovereign debt markets but had little impact on money markets, which are still discounting more monetary easing.
There were already signs that the measures agreed - which surpassed market expectations - could face obstacles.
The Finnish government told parliament on Monday that Helsinki and a like-minded administration in the Netherlands would block the euro zone’s permanent bailout fund from buying bonds in secondary markets.
Three-month Euribor rates inched lower on Monday to 0.652 percent from 0.653 percent. That was within range of a record low of 0.634 percent hit in early 2010.
Euribor rates were traditionally used as a gauge of interest rate expectations but excess liquidity in the market from two injections of long-term cash from the ECB has made it more difficult to use them as such.
Even so, Giansanti said the market was fully pricing in a 25 basis point cut in the refi rate at Thursday’s monetary policy.
“It will give a boost to sentiment, showing that the ECB is committed to doing what is needed to help the economy in the euro area,” he added.
Eonia forwards are also showing markets are pricing in a reduction in the deposit facility rate.
Eonia rates are seen reaching between 0.24 to 0.19 percent in September - below the deposit facility rate of 0.25 percent, which normally serves as a floor for overnight rates. Eonia rates were last at 0.38 percent.
Speculation of a deposit facility rate cut has increased in recent weeks on the back of comments by ECB officials.
Two ECB Governing Council members, Austria’s Ewald Nowotny and Slovakia’s Jozef Makuch, have said they could imagine the deposit rate going to zero.
Simon Peck, rate strategist at RBS, said Eonia forwards were discounting an around 9 bps decline in the deposit facility rate in July.
Peck expected the rate to be reduced to 0.10 percent or 0.15 percent this week from 0.25 percent currently and the refi rate to be cut by 25 basis points to 0.75 percent, with the possibility of a 50 basis point cut.
He too thought the market impact would be more psychological than practical.
“It’s more about signaling. It’s a statement, it’s the right policy move in the context of the weak data,” Peck added. (Editing by John Stonestreet)