Concerns over an impasse on the Greek crisis have prompted investors to pare back expectations in money markets for monetary tightening, but worries over inflation mean they will continue to price in rate hikes. Euribor interest rate futures were broadly steady on Thursday dipping in and out of negative territory.
Investors were balancing the need for higher interest rates to fight off price pressures currently running above the bank's inflation target with risks that a Greek default - if it hasppens - could have a knock-on effect on other eurozone states and dry up the regional banking system.
Upside risks to medium-term inflation outlook have emerged as the economic recovery takes hold, European Central Bank President Jean-Claude Trichet said earlier, adding the ECB was "carefully monitoring" to avoid a feed-through from commodity prices into longer-term inflation expectations. Eurozone inflation was currently running at 2.8 percent in April, above the ECB's target of maintaining it at or slightly below 2 percent.
Signs of an impasse over the Greek debt crisis heightened in recent weeks, as Greek officials could not agree on the fiscal austerity measures needed to secure more EU/IMF funding while eurozone officials were at odds over the need for Greece to restructure its debt. Before the latest escalation in the Greek debt crisis, money markets were fully pricing two more rates hikes by year-end after it raised them by 25 bps to 1.25 percent in April.
Benchmark bank-to-bank lending rates pulled further back from two-year highs as excess liquidity at just over 19 billion euros was still considered comfortable albeit far lower than the 60 billion euros at the end of the last ECB reserve period which ended May 10.