By Dhara Ranasinghe
LONDON (Reuters) - Investors no longer expect the European Central Bank to cut interest rates again this year, as data points to a pick-up in the economy and the central bank signals a reluctance to lower borrowing costs deeper into negative territory.
The ECB, which last cut rates in March, is aware of the growing costs to the financial sector of its ultra-loose monetary policy and would rather not have to keep rates negative for too long, ECB chief Mario Draghi said this week.
Forward Eonia bank-to-bank lending rates dated for the ECB's Dec. 8. meeting
This shows money markets no longer price in a 10 basis point cut in the ECB's deposit rate, currently at minus 0.40 percent, by year-end.
That contrasts sharply with June, when the market priced in an 80 percent chance of a cut as Britain's shock decision to quit the European Union fueled concerns about the outlook for growth and inflation.
Since then, economic data has picked up, while stronger U.S. numbers have has boosted expectations of a hike in U.S. interest rates in December.
In a sign that rates have bottomed out, expectations for a rate cut next year have also been scaled back, narrowing the spread between overnight and forward Eonia rates. ( http://tmsnrt.rs/2eurVHh )
Eonia forward rates price in just over a 40 percent chance of a 10 basis point cut by November 2017, and a 22 percent chance of such a move in the next six months.
"We have for now reached the lower bound for rates, which is why market participants are not assigning a high likelihood to another deposit rate cut," said Kim Liu, senior fixed income strategist at ABN AMRO (AS:ABNd).
Any further monetary easing is expected to take place through an extension of the ECB's 1.7 trillion euro bond buying scheme.[L8N1CW3X9]
"I do not think the possibility of a further cut of rates is zero, but definitely its probability is low," said Francesco Papadia, a former ECB director general for market operations.
"The reason behind this expectation has to do with both the cost and the limited benefit: there is not much mileage to be obtained by a further cut, say by 10 bps, in the deposit rate."
While ECB policymakers have played down the scope for another rate cut, investors had, until recently, been betting on one in the months ahead.
What has changed for markets, say analysts, is a growing focus on the side-effects for banks of negative interest rates, highlighted by concerns about the health of Germany's biggest lender, Deutsche Bank (DE:DBKGn).
(Graphic by Nigel Stephenson Editing by Jeremy Gaunt)