Traders Pricing ECB Rate Hikes Clash With Dim Inflation Outlook

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Traders betting that the European Central Bank will raise rates in two years time are on shaky ground if market-based inflation expectations are anything to go by.

A gauge of the projected trajectory of consumer prices shows gains will remain short of the ECB’s inflation mandate over the next three decades. That’s casting doubt over a 10-basis-points interest-rate increase that is currently being priced in by the middle of 2023.

Traders Pricing ECB Rate Hikes Clash With Dim Inflation Outlook

The wagers reflect an improving economic backdrop as vaccination rollouts in the region gather pace, with consumer prices surging 2% in May, the highest in more than two years. And it’s a stark contrast to the situation since the end of last year, when money markets were betting the resurgence of the pandemic would force the ECB to ease.

But for Christoph Rieger, head of fixed-rate strategy at Commerzbank AG, they seem premature. “I still think that a deposit rate cut is more likely than a rate hike over the next couple of years,” he said, adding that ECB can provide ample liquidity to keep the overnight rate -- off of which rate expectations are derived -- close to its benchmark.

Excess liquidity in the region rose to a record 4.18 trillion euros ($5.09 trillion) on Tuesday.

Policy makers have also been at pains to emphasize the temporary nature of price gains due to base effects and taxes, with officers including Executive Board member Fabio Panetta signalling a willingness to shrug off near-term inflationary spikes and keep policy loose for the time being.

Meanwhile, the ECB is conducting a review of it’s monetary policy which may see it follow in the footsteps of the Federal Reserve by imposing an asymmetrical inflation target. In the Fed’s case, the move was largely interpreted as sign it would to let the economy run hotter before applying policy brakes.

According to data on one-year forward rates compiled by Bloomberg Intelligence, euro-area inflation is seeing quickening to 1.65% in a decade and to 1.76% in 30 years. That would still fall short of the ECB’s mandate to keep price gains below, but close to, 2% over the medium term.

©2021 Bloomberg L.P.

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