MONEY MARKETS-Euro overnight rates set to jump higher

 * Euro overnight rates set to jump higher
* Markets see further rate hikes by July 
 * Fed may have to follow sooner than anticipated
 By Kirsten Donovan
 LONDON, April 11 (Reuters) - The Eonia overnight rate is set
to hit its highest level since February this week as the
European Central Bank's new maintenance period starts with
higher interest rates. 
 The ECB has raised its main refinancing rate to 1.25
percent, ending almost two years of record low interest rates,
and money market rates have risen as the market prices in
expectations of more tightening to come. 
 The Eonia overnight rate (EONIA=: Quote, Profile, Research), which has historically
traded just above the ECB's refinancing rate, has been
compressed by the ECB's provision of unlimited liquidity, which
will continue to cap its rise. 
 The rate began the March maintenance period at 0.84 percent
before falling to 0.54 percent -- a typical pattern as banks
tend to front-load their reserve requirements in the early part
of the period -- to give an average rate of 0.67 percent. 
 "Reflecting the hike in the refi rate, we expect Eonia to
trade higher, but remain below the refi rate because it is
driven by the excess liquidity," said Barclays Capital rate
strategist Giuseppe Maraffino.
 With excess liquidity currently at its lowest levels since
June 2009 at around 10 billion euros, according to Reuters
calculations, how much funding banks take at this week's open
market operations will be key. 
 This week 84.5 billion euros of one-week money expires,
along with 82.3 billion euros of one-month funds and with
tenders being held on Tuesday. 
 "If demand for ECB liquidity is good we could start the new
maintenance period with an excess of 30 or 35 billion euros, but
if it is low then we could see sharp tension on Eonia in the
first part of the period and volatility throughout," Maraffino
said.
 In the first case, Eonia will fix around 1.05 percent, he
said, rising to 1.10 or 1.15 percent in the latter, in either
case the highest levels since early February. 
 Excess liquidity in the money market is currently around 10
billion euros, according to Reuters calculations, the lowest
level since June 2009, just before the ECB offered banks access
to unlimited one-year funding for the first time. 
 With the ECB signalling it could raise rates further,
benchmark three-month euro Libor rates (EUR3MFSR=: Quote, Profile, Research) have
continued to rise, fixing at 1.255 percent on Monday. 
 Markets are pricing in just under a 70 percent chance that
the ECB will raise rates again in June and fully pricing a rise
by July (ECBWATCH: Quote, Profile, Research). 
 With the ECB the first major central bank to begin
tightening policy, debate is growing over whether the Federal
Reserve and Bank of England will have to follow shortly. 
 Markets however have scaled back expectations of a May hike
from the BoE and see a first rise in August, while the Fed is
not seen tightening policy this year. 
 Deutsche Bank strategists said that while the unemployment
situation in the United States is critical to the Fed's policy,
if it proves to be structural, the central bank will face a more
difficult unemployment/inflation trade-off. 
 By comparing current economic conditions with those seen in
2003, strategists said that apart from the higher level of
unemployment, current monetary policy should be at least as
tight as then.
 "The pricing in the front-end of the U.S. (curve) remains
benign ... given the overall situation of the economy
notwithstanding the level of unemployment," the bank said,
adding that this should be supportive for a trade going long
euro 1-year forward rates versus the U.S. equivalent.
 The intended Federal funds rate was 1.00 percent in the
second half of 2003, according to the central bank's website.
 (Reporting by Kirsten Donovan; Editing by Susan Fenton)

MONEY MARKETS-Euro overnight rates set to jump higher