The European Central Bank's meeting on Thursday could be decisive for bets on a June rate rise, but may have only a slight impact further out the curve and on expectations of how aggressive monetary tightening will be. Money markets are split over whether to price in an interest rate rise in June, after being close to doing so after the ECB's April meeting, as bets are fading due to a strong euro and uncertainty surrounding talk of a Greek debt restructuring.
Investors widely expect the ECB to leave interest rates unchanged at 1.25 percent this week, but will closely watch for whether President Jean-Claude Trichet uses the code words "strong vigilance" in his news conference. At the moment, a 25 basis point rate rise is fully priced in only for July, but expectations would almost certainly shift to June if he uses the code words when talking about inflation risks.
Euro overnight index swaps price in two more increases by the end of the year, with significant chances of a third. Excess liquidity was expected to increase this week from the current levels of around 34 billion euros - according to Reuters calculations - after banks borrowed 128 billion euros from the ECB in the seven-day operation on Tuesday, more than the 118 billion expiring.
Demand rose because of high Eonia fixings over the past few days, and also due to a shift towards shorter-date loans on expectations of a rising benchmark rate. Eonia fixed at 1.289 percent on Monday and was expected to fall below ECB's main rate in the next few days, but linger above 1 percent for most of the current reserve period, double the lows hit in the previous period.