LONDON - Euro zone money markets are pricing in just a 30 percent chance of a European Central Bank rate hike - of 10 basis points - in June 2019, marking a sharp scaling back of bets as economic growth slows and worries about Italy mount.
A deepening political crisis in Italy, the euro zone's third-biggest economy, fuelled a heavy selloff in Italian assets and the euro on Tuesday, in a throwback to the euro debt crisis of 2010-2012.
That turmoil comes on top of signs that the euro zone economy may have lost further momentum at the start of the second quarter, prompting markets to cast doubt over both the timing and scale of monetary tightening.
The difference between the overnight bank-to-bank interest rate for the euro zone (Eonia) and forward Eonia rates dated for the ECB's June 2019 meeting stood at 3 basis points, down from around 6 bps last week and 9 bps earlier this month.
That indicates investors are pricing in roughly a 30 percent chance of a 10 basis point increase - the minimum likely rise - in the ECB's minus 0.4 percent deposit rate.
"There is just one 10 basis point hike priced in for next year now, which is quite a sharp re-pricing of market expectations," said Frederik Ducrozet, senior economist Europe at Pictet Wealth Management.
"The ECB could still end QE (quantitative easing) in December. In a way, the market is doing its jobs for it by pushing back rate-hike expectations."
The massive bond-buying scheme is scheduled to end in September. Many economists expect the ECB to conclude it by year-end, followed by a roughly six-month gap before interest rates are raised.
The turnaround in rate expectations, with markets now fully pricing in one 10 bps rate hike by end-2019, has been significant.
This year started with them pricing in a hike as early as December, given strong data and hawkish comments from some policymakers, and earlier this month, they had priced in almost three 10 bps rises for 2019.
But growing concern about Italy and softer data have prompted a shift.
JPMorgan said last week it had pushed back its rate hike expectations from March 2019 to June 2019 after a business survey showed that euro zone economic growth slowed much more sharply than expected this month.
For some analysts, current market pricing risks getting ahead of itself.
"We think the ECB will be pragmatic and adopt policy according to economic circumstances at the time," said Sarah Hewin, chief economist for Europe at Standard Chartered.
"Chances are by then we will have a new Italian government with the chance to implement some of its policies. We can't say at this point that a June 2019 (hike) is definitely out."