(Bloomberg) — Traders are pushing back against the European Central Bank’s own guidance and betting it could deliver the smallest rate hike this cycle when it meets on Thursday.
(Bloomberg) — Traders are pushing back against the European Central Bank’s own guidance and betting it could deliver the smallest rate hike this cycle when it meets on Thursday.
The odds of a half-point hike — once all but guaranteed — are around 50% after Silicon Valley Bank collapsed. That prompted the Federal Reserve to backstop the financial system with more liquidity, spurring an aggressive repricing of the outlook for interest rates globally.
It’s a big narrative shift for a market betting on more aggressive hikes for weeks. ECB President Christine Lagarde signaled a half-point hike was highly likely at the last monetary policy meeting in February and the market has treated it as a near certainty ever since, egged on by the latest signs inflation was still not slowing.
The moves on Monday put the ECB in a tough position: dialing back on its guidance for a half-point hike could diminish the bank’s credibility, but sticking to it may be harmful for an economy that now needs to consider the fallout from any systemic risks in the US financial sector.
Plans for more big hikes are set to meet stronger opposition as dovish policymakers are likely to argue that more caution is warranted, according to officials with knowledge of the matter, who declined to be identified because such discussions are confidential.
“The ECB is in a tricky problem as it could be forced to rescind its ‘promised’ 50 basis-point rate hike for this week,” said Steven Barrow, Standard Bank’s head of Group-of-10 strategy. “If it does it would show, once again, that there is no merit in central banks telegraphing future rate moves unless policy rates are stuck at zero.”
The ECB has already lifted rates by 300 basis points since July and a quarter-point move this week would be the smallest of the current cycle. Traders see the ECB deposit rate peaking just above 3.40%, about 80 basis points lower than just a week ago.
The move in money markets was followed by a historic rally in bonds, with the yield on the two-year German note down as much as 60 basis points, on track for its biggest drop on record. US Treasury yields also tanked and at one point on Monday, traders almost entirely priced out any further hikes by the Federal Reserve.
The failure of Silicon Valley Bank over the weekend and the government rescue of its depositors has also led some economists to revise their calls for the Fed’s next steps, with Goldman Sachs Group Inc. as well as money managers at Pacific Investment Management Co. saying a pause in the cycle is possible. Bloomberg Economics says there’s also a lower chance policy makers will commit to another big hike.
Italian Finance Minister Giancarlo Giorgetti said on Monday European authorities will “evaluate” any implications for the conduct of monetary policy and for financial stability. ECB officials are in a quiet period ahead of the meeting.
“The call will be tricky with a risk of a policy mistake from both ends,” said Fredrik Repton, a portfolio manager at Neuberger Berman. “In my opinion it’s probably best from a risk management position to do a 25 basis-point move.”
For Axel Botte, a fixed income strategist at Ostrum Asset Management SA in Paris, the ECB will stick to its guidance, but hint at other measures to boost liquidity if necessary, such as extending cheap loans to banks.
“The ECB will likely do 50 basis points given the very strong guidance related to high core inflation,” Botte said. “I guess the ECB would proceed with the 50 basis-point hike and hint at new TLTRO for banks potentially.”
–With assistance from James Hirai, Libby Cherry and Alessandra Migliaccio.
(Updates ECB pricing, context.)
More stories like this are available on bloomberg.com
©2023 Bloomberg L.P.