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Fed shock pushes euro money market rates lower, eases ECB job

The euro sign landmark is seen outside the headquarters of the European Central Bank (ECB) in Frankfurt September, 2013. REUTERS/Kai Pfaffen
The euro sign landmark is seen outside the headquarters of the European Central Bank (ECB) in Frankfurt September, 2013. REUTERS/Kai Pfaffen

By Marius Zaharia

LONDON (Reuters) - Euro zone money market rates fell to six-week lows on Thursday after the Federal Reserve unexpectedly stuck to its $85 billion-a-month stimulus program, easing pressure on the European Central Bank to relax policy.

The Fed's shock decision on Wednesday means global liquidity conditions will stay loose for longer than previously expected, exerting downward pressure on interbank borrowing rates.

The recent peaks in short-term interbank euro rates were a source of discomfort for the ECB and President Mario Draghi warned earlier this month that the levels were "unwarranted" as economic recovery in the euro zone was still "green".

The reduced expectations of the ECB easing policy further limited the fall in money market rates.

"(The Fed decision) underscores that central banks remain dovish ... (but) it surely reduces the risk of another ECB rate cut," said Nordea chief analyst Anders Svendsen in Copenhagen.

The one-year, one-year forward Eonia rate, one of the most traded money market instruments which shows where one-year Eonia rates are seen in one-year's time, fell 8 basis points to 0.36 percent, 20 bps down from September highs.

Euribor futures were up to 22 ticks higher across the 2013-2016 strip, with most contracts hitting 4-6 week highs.

Higher Euribor futures indicate expectations of lower three-month Euribor lending rates, which are a gauge of future European Central Bank policy rates and liquidity conditions.

The December 2016 future rose the most, hitting a one-month high of 98.40, indicating expectations that the Euribor rate would settle at 1.6 percent at the end of 2016.

The December 2014 contract, the most liquid, hit a six-week high of 99.51, implying a 0.49 percent rate.

That was still higher that the implied 0.40 percent hit in July in the wake of the ECB's promise to keep rates low for an extended period and some way off the 0.23 percent rate implied in May before the Fed first signaled it could trim stimulus.

"Perhaps we can get back to levels seen at the beginning of July," said Simon Smith, chief economist at FXPro. "After the ECB introduced its forward guidance, tapering expectations increased and the data improved, undermining it ... so (the Fed move) gives more weight to pledges to keep rates low."

The Fed may have created other challenges for Draghi. A rising euro/dollar rate, last at its highest since February at 1.3568, could choke recovery by hurting exporters.

"Whatever they (the ECB) say now is a lot more credible because markets won't put it in the context of Fed tapering," said Abhishek Singharia, European rate strategist at Deutsche Bank. "(But) one will have to see what's happening with the FX rate because if the (euro/dollar) is quickly approaching 1.40 they might have to do something about it."

RATE HIKES PUSHED BACK

One common way of calculating rate hike expectations assumes that by the time the ECB raised rates, banking sector liquidity - now ample due to the unlimited loans offered by the ECB at the height of the crisis - would have normalized, no longer keeping money market rates artificially low.

The overnight Eonia rate would then trade close to the refinancing rate, currently 50 bps. Looking at the three-month Eonia forward curve, the rate is expected to hit 75 bps in September 2015, compared with April 2015 before the Fed meeting.

On the one-month Eonia curve, expectations of the first rate hike have moved back to November 2015 from August 2015.

Assuming liquidity conditions remain the same for the foreseeable future, expectations were pushed back to January 2015 from November 2014, according to Nordea estimates.

"The fact that we see a flattening of the curve loosens monetary conditions by itself," FXPro's Smith said.

(Reporting by Marius Zaharia, editing by Nigel Stephenson)

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