Money markets positioning for more ecb easing, but not in may

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* ECB seen on hold in May, but may ease later* Money market rates falling again across 2012 strip* Curve seen flattening as rates seen low for longerBy Marius ZahariaLONDON, May 2 Short-term euro zone interest rates predict the European Central Bank will keep policy on hold on Thursday, but pricing also implies it could ease monetary policy further in coming months as the region struggles with a painful recession. The recent re-positioning in money markets for further easing comes after a protracted period of little movement. Investors thought at the time that the ECB's injections of about one trillion euros ($1.3 trillion) of cheap loans into the banking system (LTROs) would have a significant impact on the economy and could be the central bank's last moves this year. But weak business surveys and a recent escalation of the sovereign debt crisis have signalled that the impact of the LTROs has faded and more easing may now be necessary.

"Everything is pointing towards the intensification of the contraction again," Rabobank senior market economist Elwin de Groot said. "The market is preparing for the possibility that the ECB might cut rates further down the line.""I don't think it will happen this week. The ECB would be wary of being too responsive to a small set of data."Overnight Eonia rate forwards dated on 2012 ECB meetings have fallen in the past week by around 2-6 basis points to 24-30 bps, while Euribor futures have risen, implying expectations for a further fall in Euribor rates. Longer-dated rates fell more, reflecting expectations any move might occur in the second half of the year.

Max Leung, a rates strategist at BofA Merrill Lynch Global Research, said markets were pricing in a 10-20 percent probability of a 25 bps key rate cut by midsummer and as much as a 40 percent chance of a cut by the end of the year. But he expected markets to soon price in a higher chance."The ECB said its next moves would be data-dependent. If we look at the Purchasing Managers Indexes for the euro zone, they are at levels at which the ECB cut rates back in October last year," Leung said.

"If the ECB cuts (its key refinancing rate from a record low of 1 percent), there is a decent chance that it will cut the deposit rate as well, which means there could be 10-15 basis points more to go in Eonia rates and Euribors."In his post-meeting speech on Thursday, Draghi is widely expected to remain cautious and suggest that the ECB is still in a wait and see stance. Any dovish signal he sends out would accelerate the markets' positioning for more easing. Barclays Capital rate strategist Giuseppe Maraffino said weak data and increased uncertainty about Spain could mean that markets would continue to price in a hefty chance of more easing even if Draghi gave no clues that this was likely. The markets' behaviour goes against the house view that rates will remain at 1 percent until the end of 2015, but Maraffino said it was "premature" at this point to bet against the trend and pay Eonia rates. Markets are not only pricing in a higher probability of a cut, but they are "increasingly embracing" the view that rates will stay low for longer, Societe Generale rate strategists said in a note. Having recommended a bet on a narrowing of the spread between one- and two-year rates a month ago to reflect that view, they are now recommending the same bet moved one year into the future using forward rate products.