Eurozone interest rate futures fell on Wednesday, pushing implied rates up before an ECB policy meeting expected to cement expectations for two more rate hikes by end-2011, though views are split on how soon they will come. Euribor futures fell by as much as six basis points on the September 2011 to December 2012 contracts while the 2/10-year German government bond yield curve was at its tightest since January 2009 as the front end came under selling pressure before Thursday's rate decision.
The European Central Bank's Governing Council is expected to hold its key rate at 1.25 percent when it meets on Thursday and money markets are split over whether to price in an interest rate rise in June. Strong expectations seen after the ECB's April meeting, at which it raised rates by 25 basis points, ending two years of record low rates, has faded due to a strengthening euro and uncertainty stemming from talk of a Greek debt restructuring.
The Eonia curve is pricing in a 30 percent probability of a rate hike in June and 70 percent in July, according to Barclays Capital strategists. The move in eurozone interest rate futures contrasted sharply with a rally this week in the UK market, where traders have trimmed bets on when the Bank of England will start raising interest rates after weak economic data.
Money market rates show investors are not fully pricing in a BoE rate rise until January 2012. In February, investors were pricing in three rate hikes in 2011, starting in May. The picture is the same across the Atlantic where the Federal Reserve is also expected to start raising in early 2012, putting into sharp focus the UK, US and ECB policy divergence. "For the time being one of the best ways to express that (divergence) is in short end spreads. We're short front-end of eurozone versus either the US or the UK because we think that trend that could continue in the near term," said Charles Diebel, head of market strategy at Lloyds Bank.
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