Wait-and-see ECB lifts Bund yields, euro money market rates

Reuters

* ECB disappoints some with no hint of imminent easing

* Short-term euro zone money market rates rise

* Traders push back bets on ECB easing to later this year

* German 10-year yields rise to one-week high

By Emelia Sithole-Matarise

LONDON, Feb 6 (Reuters) - The euro hit a one-week high while top-rated euro zone government bond yields and money market rates rose on Thursday after the European Central Bank gave no hint of imminent monetary policy easing.

The market had been expecting a strong signal of further policy stimulus from the ECB after a surprising fall in euro zone inflation to 0.7 percent, well below the bank's target of nearly 2 percent, and with money markets volatile as excess cash in the system dwindles.

ECB President Mario Draghi said the bank held interest rates steady at a record low of 0.25 percent on Thursday because it needed to acquire more information.

While reiterating that the ECB remained ready to act, he said there was no discussion over suggestions the bank stop draining from bond markets cash equal to its crisis-era bond purchases every week to boost liquidity, disappointing those in the market who had expected such a move.

Money market rates implied by Euribor futures in 2014 to 2016 rose by 3 to 6 basis points, while German two-year bond yields jumped 6 bps to 0.14 percent, their highest in a week. German 10-year yields, the benchmark for euro zone long-term borrowing costs, were up 6.5 bps at 1.61 percent.

"The market went a bit too far over the last few weeks in expecting something from the ECB so the negative reaction is disappointment but we still think the ECB will deliver," said BNP Paribas strategist Patrick Jacq.

In the forward interest rate market, euro overnight lending rates for this year rose by up to 3 bps after Draghi's comments. Notably, March Eonia was in line with recent spot Eonia fixings around 0.16 percent, up from 0.13 percent before Draghi spoke, reflecting scant expectations of a rate cut next month.

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However, May to November rates were below the spot rate, around 0.11 percent, as traders pushed back predictions for further action later in the year.

Some in the market say a fresh spike in money market rates, at which banks lend to each other and which set the baseline for the cost of lending across the economy, after Thursday and against a backdrop of shrinking excess liquidity could still force its hand in March.

The ECB wants to prevent such a rise in short-term rates because that would effectively tighten monetary conditions, putting pressure on economic growth and potentially pushing the euro zone's already sub-target inflation even lower.

"Overall, the ECB is behind the curve and we think the market will remain convinced the ECB is locked into low rates and can cut the refi rate again," said strategists at RBS, who had expected a cut in the bank's refinancing rate on Thursday.

The euro rose to a one-week high against the dollar of 1.3619 and a 2014 high against the British pound after the ECB press conference.

The single currency's correlation with Eonia has tightened in the past few weeks, highlighting how short term rates will be key drivers of the euro in coming weeks.

"The fundamental outlook for the euro zone remains challenging and disinflation could worsen from here not least because of persistent euro resilience," said Valentin Marinov, currency strategist at Citi.

"Renewed escalation of money market tensions could keep markets betting on more (conventional and unconventional) ECB measures before long."

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