ECB policymakers are leaning towards a half-percentage-point rate hike on Thursday, a source close to the ECB's rate-setting Governing Council said on Wednesday.
This was before Credit Suisse shares slid to a new record low, after its largest investor said it could not provide the Swiss bank with more financial assistance.
With turmoil engulfing markets just starting to stabilise after the sudden collapse of Silicon Valley Bank, investors questioned whether the ECB would be able to deliver a large rate rise on Thursday.
Money market pricing suggested traders now saw just a roughly 30% chance of a 50 bps ECB rate hike, down from as high as 90% at the start of the session.
In further signs that unease was spreading, the euro slid almost 1.8% against the dollar its biggest one-day drop since the height of the COVID-induced market turmoil of March 2020
"The instability has raised questions if the ECB will go ahead and raise rates by 50 bps as originally planned tomorrow," said Kenneth Broux, senior currency and rates strategist at Societe Generale. "The repricing of a lower ECB terminal rate is weighing on the euro."
Markets now priced euro zone rates would peak at around 3.2% this year, down from just over 4% last week.
"Tomorrow the easy decision for the ECB is to do 25 bps and then continue the hiking cycle, but also point to the risks right now. Then should this calm down, come May, they could still increase the hiking pace to 50," said Piet Christiansen, chief analyst at Danske Bank.
Germany's two-year government bond yield, sensitive to interest rate expectations was down a massive 50 basis points at 2.42%, and the gap between closely-watched Italian and German government bond yields moved back towards 200 bps.
Analysts also said that banking fears spreading to Europe through Credit Suisse could prompt the ECB to announce a new liquidity backstop.
Were the ECB to announce a facility, Christiansen at Danske Bank said it could be a one-year liquidity operation acting as a backstop at the average deposit rate, compared to current weekly and three-month operations at the more punitive main refinancing operations rate.
ECB officials contacted lenders it supervises to ask about financial exposures to Credit Suisse, the Wall Street Journal reported on Wednesday, citing people familiar with the matter.
(Reporting by Joice Alves and Alun John in London, and Yoruk Bahceli in Amsterdam, Writing by Dhara Ranasinghe; Editing by Toby Chopra)
