Investors see scant chance of ECB rate hike over next year

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[August 29, 2017]  By Dhara Ranasinghe

LONDON (Reuters) - Investors have all but ruled out the chances of an interest rate hike from the European Central Bank over the next year given dovish policymaker comments, a surge in the euro and subdued inflation.


After remarks from ECB chief Mario Draghi in Sintra, Portugal, in late June were seen as signaling a policy change, money markets quickly shifted to reflect expectations for a rate rise as early as mid-2018.

But those bets have been scaled back as recent comments by ECB officials and inflation, well below the ECB's near 2 percent target, prompt investors to reassess their most aggressive rate-hike bets.

Forward Eonia bank-to-bank rates, a closely followed gauge of the market's rate expectations, dated for the ECB meeting next June stand at minus 0.35 percent, just a basis point above the Eonia spot rate of minus 0.36 percent. <ECBWATCH>

That gap implies markets attribute just a 10 percent probability to a 10 basis point hike by next June - a move that was fully priced in back in early July.

"Post Sintra, we've had some dovish talk from the ECB with the taper announcement not expected until the autumn," said Martin van Vliet, a senior rates strategist at ING, referring to when the central bank may signal when it will begin scaling back its bond purchases.

"Draghi didn't say anything at Jackson Hole either and we have the euro at $1.20. Because of this I think most people have given up on the idea of a rate hike as soon as next year."

Draghi, in a highly anticipated speech at a central bank gathering in Jackson Hole, Wyoming, last week, did not give the markets any new clues on monetary policy.

A rally in the euro to above $1.20 <EUR=> meanwhile has cemented expectations the ECB will strike a cautious tone when it meets next week.

The single currency has gained more than 14 percent this year, dampening the price of imported goods and helping to keep inflation subdued. Inflation in the bloc is 1.3 percent.

Against this backdrop, market expectations for a rate rise later next year have also been scaled back.

Eonia futures suggest roughly a 30 percent chance of an increase in the ECB's minus 0.40 percent deposit rate by next September and around a 60 percent chance of a move by the end of 2018.

This is also down sharply from early July when market pricing showed investors anticipated a hike by mid-June next year and a high chance of a second move by the end of 2018.

"I don't see the ECB hiking rates in the next couple of years -- excepting an inflation surprise which isn't being priced in by markets," Rory McPherson, head of investment strategy at Psigma Investment Management, told Reuters' Global Markets Forum.

(Reporting by Dhara Ranasinghe, Graphic by Ritvik Carvalho, Editing by Hugh Lawson)

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