Friday, November 26

The market mistrusts the ECB and expects it to raise rates in 2022

The distrust of the monetary policy of the European Central Bank (ECB) in the markets it has been noticed more than ever.

Despite the fact that the president of the organization, Christine Lagarde, insisted at the last press conference that inflation is temporary and that they will maintain an accommodative policy, investors don’t see it that way.

And it is that the market expects that the rate hike that the Federal Reserve is preparing for next year will be a catalyst for the ECB to do the same by the end of 2022.

Two rate hikes in December

By the time the October ECB meeting ended, The markets bet on a rate hike of 10 basis points for July 2022 and two hikes for October 2022.

Although the inaction of the Bank of England, which left interest rates unchanged when it was expected to be the first major central bank to raise rates, it made expectations loosen.

However, October inflation figures in the United States, which were higher than expected on Wednesday, to 6.2 percent from 5.9 percent of the consensus, came back to the fore as the determining factor. so that a rate hike by the Fed is not delayed for longer, being faster than expected.

The US inflation data, therefore, translated into new expectations of increases for the ECB for September 2022 which would be joined by another two increases for December 2022 on Friday.

The key is in the swaps

To make such a claim, heAnalysts have looked at swaps, which registered big movements this week.

For instance, spreads on two- and five-year swaps are at their highest since the beginning of the pandemic, in a sign that markets are beginning to be risk-averse.

Analysts say the bond shortage heading into the year should support bond prices, which move inversely to yields.

For their part, swap spreads may reflect more expectations of rate hikes and tension in money markets.

The market presses and the ECB resists

Inflation will continue to rise, have recognized different voices from the ECB. Thus, they expect it to remain high until the first quarter of 2022, when it would begin to moderate.

And they press for the ECB to advance the decision that was not foreseen until the end of 2024 or even early 2025.

What is holding the ECB back? The body wants to be very cautious. The mistakes made at the dawn of the financial crisis when the then-president of the ECB, Jeann Claude Trichet, raised interest rates (in 2009 and 2011) with similar inflation, while the rest of the central banks cut rates.

Jon Day, Fixed Income Portfolio Manager at Newton Investment Management, part of BNY Mellon Investment Management explains that “the ECB tried to roll back market expectations at its October meeting, but still strongly believes that inflation is transitory and it will fall towards the target next year, but even the ECB admitted that inflation will last longer than expected ”.

The analyst adds that “yields in the euro area are still very low by global standards, reflecting the ECB’s ultra-flexible monetary policy, they are still low value compared to markets that are evaluating rate normalization.”

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