Investors are betting that stubbornly high inflation will force the European Central Bank to raise interest rates more than once this year, in a challenge to the central bank’s insistence that it expects to stay on hold in 2022.
Markets have this week pulled forward expectations of tighter policy, with an increase in the central bank’s deposit rate to minus 0.25 per cent – from the current record low of minus 0.5 per cent – now priced in by December, implying traders expect at least two 0.1 percentage point rate rises. The shift comes just before members of the bank’s governing council are set to meet on Thursday to discuss monetary policy.
Before last week’s hawkish US Federal Reserve meeting, which kicked off a fresh round of speculation that the ECB will be forced to follow in the Fed’s wake as it lifts borrowing costs, markets were pricing in a much smaller rise to minus 0.4 per cent by the end of the year.
The growing conviction in markets that eurozone rates are set to rise for the first time since 2011 comes despite Christine Lagarde’s repeated rejection of calls for earlier tightening, with the ECB president saying last month that it has “every reason not to act as quickly or as ruthlessly ”as the Fed.
“The ECB has stuck to the mantra of no rate hikes this year, but the market is clearly challenging that view,” said Richard McGuire, a rates strategist at Rabobank. “Investors think the ECB might get spooked by this shift in inflation.”
Rate-rise expectations have rekindled a sell-off in eurozone bonds this week, pushing Germany’s 10-year borrowing cost – a key benchmark for assets across the currency bloc – above zero. German two-year yields, which are highly sensitive to rate expectations, have climbed sharply since last week to a six-year high of minus 0.48 per cent on Tuesday, rising above the ECB’s deposit rate for the first time since 2015.
On Thursday, Lagarde is expected to be pressed on whether she still thinks eurozone inflation will fall below the ECB’s 2 per cent target in the fourth quarter and if the central bank remains “very unlikely” to raise interest rates this year.
Inflation has been exceeding the ECB’s expectations for several months and hit a record high in the eurozone of 5 per cent in December. A report due on Wednesday is expected to show that the pace of inflation eased to 4.4 per cent last month. But after readings on German, Spanish and French inflation exceeded expectations in January, economists say price pressures seem likely to continue overshooting ECB forecasts at the start of this year.
Spyros Andreopoulos, a senior European economist at BNP Paribas who used to work for the ECB, has discovered recent hints that the central bank’s policymakers are worried inflation may stay higher for longer.
“They are slowly changing their minds and for good reason because what we are seeing is broad-based price pressure increasing,” he said, adding that if Russia invades Ukraine it could cause further surge in energy prices and push eurozone inflation above 6 per cent.
Longer-lasting price pressures could spur the ECB to act sooner than it currently expects, according to some investors. “If inflation stays high I don’t think it’s unreasonable to expect [the central bank’s bond-buying programme] to stop before the end of the year, and then they could potentially hike in December, ”said Gareth Colesmith, head of global rates at Insight Investment.