Money markets are expecting an extended pause in the ECB's monetary tightening cycle as concern over weak growth in the region's peripheral economies outweighs any relief from a bumper new deal to stem the debt crisis. Politicians last week agreed on a wide-ranging package of measures designed to relieve the debt burden on Greece and stop the region's crisis from enveloping the larger and systemically important economies of Spain and Italy.
A high degree of uncertainty ahead of the deal pushed back expectations of another interest rate rise by the European Central Bank into 2012. While last Friday's package brought some relief to bond investors, money market participants remain sceptical that the ECB can continue to justify raising interest rates to curb inflation in core economies. The Eonia overnight rate curve showed a spread of 11 basis points in rate expectations between the ECB's next meeting in August and the first policy meeting of next year, implying a less than 50 percent chance of another hike.
When the central bank raised rates earlier this month, another hike by January was seen as highly likely. Given the weak economic data, especially from peripheral states, markets may come to consider the July rate hike as a policy error, said Royal Bank of Scotland strategists, who now recommend targeting a further flattening of the Euribor curve.
The bank's strategists said the spread between June 2012 and June 2014 Euribor futures contracts was too wide. The spread was last at 88 bps, with RBS targeting 65 bps. In the near term, demand for European Central Bank loans was expected to drop at a weekly tender on Tuesday.