* ECB rate hike likelihood rises after Fed comments
* Euribor curve steepens, seen near 1 pct by end 2013
* First rate hike priced in after 18 months to two years
By William James
LONDON, March 14 (Reuters) - Euribor futures contracts fell on Wednesday, pricing in higher euro zone interest rates over the long term after a slightly more upbeat economic assessment from the U.S. Federal Reserve caused investors to rethink their rate outlook.
The Euribor curve steepened, implying higher European Central Bank rates in the future, with the biggest rise in expectations for the period from December next year.
Analysts said the combination of the Federal Reserve’s acknowledgement that the U.S. economy was recovering and the ECB’s continued focus on inflation meant markets were increasing bets that central bank rates would rise.
“The market is starting to position for a central bank that will start to increase rates in the U.S. and later in the euro area,” said Alessandro Giansanti, strategist at ING in Amsterdam.
“The data that is coming out is better than expected in Germany and the U.S. and then we have inflation pressure in the euro area... the ECB is very sensitive to inflation.”
At the latest central bank meeting on March 8, ECB President Mario Draghi said inflation rates were likely to stay above 2 percent in 2012, with a persistent risk of a fresh increase.
June 2012 Euribor futures fell 1 tick to 99.29 while the December 2013 contract slid 6.5 ticks to 99.025.
This curve steepening move shows the three-month Euribor rate is seen falling to around 70 bps in the near term, weighed down by huge cash surpluses in the banking system, but rising back to around 0.975 percent by the end of next year on the prospect of a rising base interest rate.
The ECB pumped over a trillion euros of three-year loans into the banking system in two long-term refinancing operations (LTROs) since late December in a bid to shore up banks’ funding positions and encourage them to lend to companies and households.
“Given the amount of excess liquidity in the system and the fact the economy is not going to pick up significantly near term, we will have a building of those expectations especially in the back end of the curve,” said Alessandro Tentori, strategist at BNP Paribas in London.
Three-month Euribor rates, which are closely correlated to central bank rate expectations, fell to 0.871 percent on Wednesday.
However, the pace of the decline in daily fixing, which has fallen 55 bps since late December, was checked by the swing in market expectations - marking its smallest day-to-day fall in three weeks.
“Even here at the short end, the prospect of money market rates moving lower for some more time to come has been reduced. In total it sums up to some curve steepening,” said Benjamin Schroeder, strategist at Commerzbank.
However, although the changing U.S. outlook had altered expectations, the precise timing of when the market now expected the next rise remained difficult to gauge.
“If you make the assumption that the liquidity is going to stay there for three years because it’s likely to remain locked into the LTROs, then you can see that a 25 bp increase in rates is priced-in between eighteen months and two years out,” said JP Morgan fixed income strategist Fabio Bassi.
However, he cautioned that the potential for both liquidity conditions and the expected path of central bank rates to change made it difficult to draw firm conclusions on what the market is pricing so far out along the curve.