Markets bet on December ECB rate cut as virus fears escalate

By Yoruk Bahceli

LONDON (Reuters) - Euro zone money markets started to fully price in a December European Central Bank interest rate cut on Wednesday, as the spread of the coronavirus outside China prompted traders to ramp up expectations for more stimulus.

Eonia money market futures dated for the ECB's Dec. 10 meeting showed about 10 basis points of rate cuts priced in. That is up from around 7.5 bps on Monday <ECBWATCH> and implies a 100% probability of a 10 bps cut at that time.

The chance of a July cut rose to around 70% from 50% on Monday.

Europe's worst flare-up of the virus in Italy has raised fears of a recession there, and Asia excluding China reported hundreds of new cases on Wednesday as the United States said a pandemic was inevitable.

Rate cut expectations have risen more broadly across money markets in recent weeks as analysts try to gauge the extent of the outbreak's economic impact and the support needed to mitigate it.

Traders are pricing in more than two rate cuts from the U.S. Federal Reserve by the end of the year <FEDWATCH> and a Bank of England cut by September <BOEWATCH>.

Euro zone money markets ramp up ECB rate cut bets after coronavirus threats: https://fingfx.thomsonreuters.com/gfx/mkt/13/2555/2523/eonia%20curve%20feb%2026.png

ECB policymaker Francois Villeroy de Galhau said on Tuesday there was currently no need for more monetary policy action in the face of the outbreak.

With opinions divided on how effective negative ECB rates have so far been in supporting the region's sluggish economy, ING senior rates strategist Antoine Bouvet was sceptical about prospects of more stimulus.

"The ECB is not going to cure anyone from the disease. You can even have doubts about how rate cuts would help economic growth," he said.

A newspaper report that Germany plans to temporarily suspend its debt brake to give relief to local governments drove its bond yields higher on Wednesday. The plan, proposed by the finance ministry some months ago, would see the federal government assume some of the debts held by municipalities.

The 10-year Bund yield rose 4 basis points to -0.47%, bouncing off 4-1/2 month lows hit earlier on coronavirus-linked concerns. It was last up 2 bps at -0.49% <DE10YT=RR>.

"This is more likely to be a short-lived move and the overall risk-off environment should prevail," said Christian Lenk, rates strategist at DZ Bank, citing past reactions to similar news.

Money markets maintained their expectations for an ECB cut despite the report.

"Not only is there a big budget surplus; there is a lot of spare capacity for easing so I don't think it will lead to major changes in Germany's funding plans," Lenk said.

Greek government bonds led a southern European sell-off as the risk-off tone prevailed across markets. The 10-year yield, which had fallen below 1%, rose 14 basis points on the day to 1.20%, its biggest rise in over 3-1/2 months. <GR10YT=RR>.

(Reporting by Yoruk Bahceli, additional reporting by Dhara Ranasinghe and Tommy Reggiori Wilkes; Editing by Marc Jones and John Stonestreet)