Investor hedges push ECB rate hikes beyond forecasts

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LONDON — While economists have become enthusiastic about the idea that the euro-zone deposit rate will reach 0% by 2022, most view rate hikes of more than 100 basis points by the end of the year as excessive.

However, interest rate futures suggest that the European Central Bank (ECB)’s first rate hike since 2011 is likely to take place in July, with 110 basis points (bps) priced in by December.

And policymaker Klaas Knot on Tuesday raised the possibility of a 50 basis point hike in July, fueling further speculation about a rise in a market already adjusting to a new era of high inflation.

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With the eurozone deposit rate still at -0.5%, analysts agree that a move in July now seems likely, but their expectations about the degree of monetary tightening the ECB will bring about differ widely from those of the markets.

Morgan Stanley expects the ECB to leave negative interest rates in September with two more hikes in 2023, Generali Investment and Janus Henderson see interest rates rise to 0%.

Analysts and market expectations have diverged widely as money market futures are used as an insurance policy against inflation risks, which has exacerbated what is being priced in by investors, analysts say.

The strength of long-dormant inflation in the euro area, now at a record high of 7.5%, has taken investors and the ECB by surprise.

For HSBC European interest rate strategist Chris Attfield, current money market pricing is akin to “a sort of insurance against the worst-case scenario… in case inflation continues to surprise positively.”

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He expects the final rate of the ECB, where this walking cycle ends, to be 1.5% in 2023.

The rush to hedge loan portfolios in March and April, just as the ECB became more aggressive, also accelerated what had been priced in by money market futures.

JP Morgan said a rush to ditch the Japanification theme — a notion that predated the COVID-19 pandemic that the eurozone was stuck in a low-inflation environment — forced interest-rate-risk investors to divest their exposure to longer-term bonds. .

The US bank said an “abrupt price revision” of two-year euro-denominated swap rates, with investors trading one form of interest rate risk for another, has caused one of the largest quarterly changes in two-year swap rates.

Finally, as the United States boosts global interest rate expectations, an increasingly aggressive tone from the Federal Reserve and aggressive market prices for Fed moves pushed euro area interest rates higher.

“If you think that 10 full-year rate hikes are priced in for the Fed, I understand the logic that you think the ECB should just follow,” said Wouter Sturkenboom, chief investment strategist for EMEA and APAC. at Northern Trust Asset Management.

He expects two 25 bp rate hikes from the ECB this year and another six to seven steps from the Fed.

(Reporting by Stefano Rebaudo; editing by Dhara Ranasinghe and Alexander Smith)

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Amanda Peterson: Amanda is an economist turned blogger who provides readers with an in-depth look at macroeconomic trends and their impact on businesses.

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