Investors are no longer expecting a rate rise from the European Central Bank by March 2018, money market pricing suggests, marking a sharp reversal in expectations for higher interest rates from just a month ago.
ECB policymakers’ comments playing down the scope for near-term changes to monetary policy, along with falling inflation expectations, explain the reassessment.
Money market rates tell the tale. Forward Eonia bank-to-bank rates – the best gauge – dated for the ECB meeting on March 8 next year stand at around minus 0.34 per cent, two basis points above the Eonia spot rate of minus 0.36 per cent.
Such a gap indicates markets are pricing in just a 20 per cent chance of a 10 basis point hike in the ECB’s minus 0.40 per cent deposit rate by next March.
That’s a sharp contrast to last month, when investors ratcheted up rate-hike expectations after the ECB at its March 9 meeting signalled a diminishing urgency for more policy action.
Soon after, some policymakers even raised the prospect of raising rates before quantitative easing ends.
A long-term gauge of eurozone inflation expectations tracked by the ECB, the five-year break-even forward, has fallen in recent weeks to stand at around 1.60 per cent – below the ECB’s near two per cent target
As a result, markets moved swiftly in March to fully price in a rate hike in the first quarter of 2018 and as much as an 80 per cent chance of a rate rise in December, when the ECB’s asset-purchased scheme is scheduled to end.
Now, markets have also unwound expectations for a rate rise by year-end with Eonia forward rates dated for the December 14 meeting indicating a less than 20 per cent chance of a move.
“The market has pretty much priced out everything,” said Peter Schaffrik, head of European rates strategy at RBC Capital Markets.
“It is a combination of the rhetoric, which has played a crucial role, but also falling inflation expectations.”
Prospects for the eurozone economy have improved but the time to withdraw support has not yet come, three ECB rate setters said on Wednesday, days before a tense French presidential election and the ECB’s own policy meeting.
Data meanwhile has shown inflation in the eurozone has slowed from four-year highs of two per cent hit in February.
A long-term gauge of eurozone inflation expectations tracked by the ECB, the five-year break-even forward, has fallen in recent weeks to stand at around 1.60 per cent – below the ECB’s near two per cent target. Disappointing US economic data and signs that the Trump administration will struggle to push through tax cuts have also quelled expectations of faster inflation in the United States.
That has had a dampening impact on rate-hike expectations in the eurozone as well, analysts said.
The money market curve has flattened and two-year Eonia money market swap rates, also viewed as an indicator of ECB monetary policy, have fallen.
In the US, the Federal Reserve hiked rates on March 15 after a string of hawkish comments from officials triggered a rapid turnaround in market expectations for a move then.
The fact that in recent weeks rate expectations in Europe and the US have swung around rapidly highlights market sensitivity as central banks move towards normalising ultra-easy monetary policies put in place after the financial crisis as economic growth improves.
“Markets are quite sensitive now that we are running towards the end of (asset-purchasing),” said ING rates strategist Benjamin Schroeder.