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 Growth concerns in China, which accounts for almost half of global
copper demand and 70 percent of iron ore consumption, have sent
commodity prices tumbling in recent weeks.
The Thomson Reuters Commodities Research Bureau index <.TRJCRB> slid
10 percent in July to its lowest levels since early 2009, when the
world economy was mired in crisis and recession. Copper fell to
six-year lows this week while oil also dipped close to its lowest in
four months.
Such developments have reverberations across the world, hitting
inflation and growth expectations. In the euro zone, the ECB's
preferred measure of the market's inflation expectations fell to its
lowest in nearly two months <EUIL5YF5Y=R>.
Accordingly, money markets see a heightened policy response. The ECB
is now expected to marginally lift rates in four years, compared
with three years a month ago.
For a graphic, click on: http://link.reuters.com/cej35w
Any delay in moves by the ECB to normalize the policy might be
preceded by an extension of its trillion euro bond-buying program,
due to end next year, traders and strategists say.
The quantitative easing (QE) scheme, was launched in March with a
September 2016 end date, although the ECB has kept an open mind
about its size and scope from the beginning.
"This surprise reaction is due to the fact that commodity prices
have fallen quite markedly," said Cyril Regnat, fixed income
strategist at Natixis, referring to money market moves.
"We have these expectations of lower demand from China and ... that
leads to lower inflation expectations in Europe. The market is
pricing in an extension of the current QE program."
The International Monetary Fund warned on Monday that euro zone
growth prospects were modest and urged the ECB to keep its money
presses rolling.
With spot Eonia rates <EONIA=> at about -0.11 percent, the zero
level on the forward curve is widely considered the point at which
the market is pricing in a rate hike, as it is assumed that any such
move would reverse the ECB's last rate cut, which was by 10 basis
points.
Four-year Eonia rates are now zero. A month ago, it was three-year
rates that traded at zero. <EUROIS=ICAP>
The speed with which the ECB hikes rates thereafter is also seen
slowing. Ten-year Eonia rates have fallen to about 0.75 percent from
roughly 1 percent a month ago.
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MORE QE?
When banks have plenty of cash beyond what they need for day-to-day
operations, as at present, Eonia rates usually stabilize at slightly
less than 10 basis points above the ECB's deposit rate, now set at
-0.20 percent, and there is no indication this floor would be
lowered further.
Excess liquidity <ECBNOMLIQ=>in the euro system stands above 400
billion euros. Historically it has only had a notable impact on
money market rates when it was below 100 billion.
Therefore it cannot be assumed that money markets are pricing in
more QE. But this is what the market talks about.
"I recall that early on in the year we had discussions about
tapering QE earlier now we talk about it being extended," said
Benjamin Schroeder, rate strategist at Commerzbank.
"Overall I think it is more likely it would be lengthened than
shortened and the market has moved in that direction."
The picture remains brighter than in March-April, however, when
deflation fears meant the ECB was not expected to raise rates for
six years.
(Graphic by Vincent Flasseur; Editing by Catherine Evans)
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