Escalating credit concerns in the eurozone periphery on Wednesday were not seen denting the European Central Bank's intention to raise interest rates on Thursday, but left the outlook for further rate hikes this year hanging in the balance.
Pricing of overnight rates linked to Thursday's ECB meeting showed markets had little doubt the central bank would follow through on a 25 basis point interest rate hike signalled in June, taking rates to 1.5 percent in a bid to cool rising prices.
"It really depends how Mr Trichet brings the message. To some extent he has to sell the rate hike, so there has to be a hawkish element to his comments," said Elwin de Groot, senior market economist at Rabobank. "But I wouldn't be surprised if it also contains quite a bit suggesting there is increased uncertainty relating to the sovereign debt turmoil."
Expectations for another rate rise later this year were hit by renewed stress in bond markets after Moody's cut Portugal's credit rating into junk territory, prompting yields to soar on bonds issued by all the eurozone stragglers. Euribor futures rallied across the 2011/12 strip, reflecting growing credit concerns and reduced expectations of future interest rate rises. The December 2011 Euribor futures contract was 4 ticks higher at 98.100.
The ECB is currently caught between the need to temper rising prices in core eurozone economies and to avoid suffocating the chances of economic recovery in weak, crisis-stricken peripheral states. "I'm not sure that the conflict and pressure in the euro area periphery is enough to decelerate the policy path of the ECB, given the absolute level of rates we are starting from," said Matteo Regesta, strategist at BNP Paribas in London. The Eonia overnight rate curve showed around 22 basis points of a third rate hike this year was priced into the fourth quarter, with October seen as the most likely month for a rise.
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