MONEY MARKETS-U.S. commercial paper market expands

* U.S. commercial paper market expands

* U.S. short rates near zero, anchored by Fed policy

* UK April rate rise expected but future policy unclear

* Portugal turmoil, Spanish bank downgrade muted impact

By Ellen Freilich

NEW YORK, March 24 (Reuters) – The U.S. commercial paper
market expanded in the latest week, pointing to growing credit
demand to fund payrolls and inventories in the economy, Federal
Reserve data showed on Thursday.

The size of the U.S. commercial paper market rose $4
billion on a seasonally adjusted basis to $1.08 trillion
outstanding in the week ended March 23 from a seasonally
adjusted $1.076 trillion outstanding a week earlier.

The size of the market without seasonal adjustments rose
$7.7 billion to $1.135 trillion.

“There’s plenty of demand out there and funding levels are
attractive, and that’s been true for months,” said Thomas
Simons, money market economist and vice president,
fixed-income, at Jefferies & Co. in New York.

Meanwhile, short-term U.S. rates remained hovered just
above zero, anchored by the Federal Reserve’s policy of keeping
the overnight fed funds rate near zero for an extended period.

In London, money market indicators showed a growing
conviction that the ECB would follow through with its signalled
interest rate hike in April, but uncertainty over the pace of
further rises looked set to persist.

Policymakers insist that the central bank’s intention to
tighten policy in response to rising prices remains unmoved by
the threat of slower global growth stemming from Japan’s
earthquake and conflict in oil-producing regions.

Market levels on the interbank overnight curve showed a 25
basis point rise in the European Central Bank’s refinancing
rate was fully expected at the bank’s April meeting.

Overnight Index Swaps linked to the April 3 meeting
(EUIRP25O1=R: Quote, Profile, Research) have risen to their highest levels since ECB
President Trichet surprised markets at the March policy meeting
by signalling a rate hike was likely next month.

However, the picture of how high rates will be by December
remains cloudy.

“The market is still to a certain extent in disbelief
because it’s looking at an environment where we think global
growth will slow appreciably in the second half of the year,”
said Societe Generale’s chief European economist James Nixon.

“The market’s concern is that in that environment… is the
ECB really going to be in a position to say risks to inflation
are on the upside?”

The OIS curve (ECBWATCH: Quote, Profile, Research) suggests two rates hikes are fully
expected by the end of the year with about a 60 percent
probability of a third, assuming ECB liquidity policy is
normalised by year-end.

But that could change.

“The market will probably gradually shift to three, rather
than two (rates hikes) especially after the ECB delivers its
first one,” said Patrick Jacq, strategist at BNP Paribas.

“If you are optimistic regarding growth, given the outlook
on inflation, it still makes sense to play steepening at the
front end,” he said.

The euro zone’s unfolding peripheral debt problems are also
not expected to derail the ECB’s rate hike plan, even as
Portugal slides ever closer to asking for a financial bailout.

Even as bond markets heaped pressure on Portugal, there was
little evidence of contagion to interbank lending since much of
the turmoil had been anticipated since the start of the year.

Market participants said there was also limited impact on
unsecured interbank lending from the decision by rating agency
Moody’s to downgrade 30 Spanish banks. [ID:nLDE72N0B1]

In Asia, analysts said Bank of Japan’s holding of bank
reserves will likely hover near record levels into month-end
when the fiscal year finishes, even as credit conditions have
normalized since it pumped trillions of yen into the system in
reaction to the massive earthquake.

The central bank is expected to leave ample cash in the
system through next week to meet demand for companies to settle
year-end payments, but analysts said it was tough to know how
quickly the BOJ would pare the current account balance,
projected to hit a record 42.6 trillion yen on Thursday.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For a graphic on BOJ's current account balance, click on: http://graphics.thomsonreuters.com/11/03/JP_BOJCRRAC0311_CT.gif ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
(Additional reporting by William James in London, Akiko Takeda
in Tokyo, Richard Leong in Hong Kong; Editing by Andrew Hay)

MONEY MARKETS-U.S. commercial paper market expands