May 9, 2018 / 9:40 AM / 16 days ago

UPDATE 1-Investors push back ECB rate-hike bets further into 2019

(Adds details, comments, chart)

By Dhara Ranasinghe

LONDON, May 9 (Reuters) - Investors are pushing back expectations for a rise in euro zone interest rates further into 2019 against a backdrop of soft economic data and disappointing inflation numbers, money market pricing suggests.

The European Central Bank will not easily retreat from plans to end its bond purchases this year, even though growth is slowing, but it may push out expectations for interest rate increases to maintain the flow of money and support confidence.

Investors, it appears, are already moving in that direction with their views on the rate trajectory.

The difference between the overnight bank-to-bank interest rate for the euro zone (Eonia) and forward Eonia rates dated for the ECB’s June 2019 meeting was around 7.5 basis points on Wednesday, down from almost 10 basis points just two weeks ago.

Analysts say that means investors are pricing in around a 75 percent chance of a 10 basis point increase in the ECB’s deposit rate - the minimum it is likely to increase - from minus 0.4 percent currently.

A rate hike by July 2019 is fully priced in by markets.

That contrasts with three more rate hikes expected from the U.S. Federal Reserve over the remainder of the year after a cumulative 150 basis points in hikes since December 2015.

The euro zone economy has expanded for 20 straight quarters, but a string of recent indicators suggests that growth has slowed in early 2018, with the threat of a global trade war further clouding the outlook.

Data last week showed inflation in the bloc slowed unexpectedly to 1.2 percent in April - remaining well below the ECB’s near 2 percent target.

A key market gauge of long-term inflation expectations, the five-year, five-year forward, has pulled back to around 1.70 percent from eight-week highs hit in April.

“The reason we’ve had such a move in rate-hike expectations is that the inflation numbers were the cheery on the cake of a recent slew of soft data,” said Richard McGuire, the head of rates at Rabobank in London.

“The ECB will err on the side of caution, which is why you will see rate-hike expectations pushed further into the future.”

Market pricing for the ECB’s first rate rise of this economic cycle have had a rollercoaster ride in the space of a few months.

In January, strong data and hawkish comments from some central bank officials prompted investors to bet that the ECB could hike interest rates as early as year-end.

Those bets were slowly unwound, pushing out to the first quarter of 2019, with the consensus later building around mid-2019 as economic data disappointed.

A weakening in the euro also reflects a curtailing of investors’ rate-hike expectations. The single currency slid to a new 2018 low on Wednesday just above $1.18.

“Short term interest rates are predicting deposit rates to hit 0 percent by the end of 2019 - that is an unsustainable scenario if growth doesn’t pick up soon,” said Rishi Mishra, interest rates strategist at Futures First Info Services.

Reporting by Dhara Ranasinghe Editing by Alison Williams

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