Markets turbocharge bets that ECB will lead world on rate cuts

INVESTORS are betting that Europe will lead the world’s largest central banks on interest-rate cuts after one of the region’s most hawkish policymakers described a slowdown in inflation as “encouraging”.

Markets are pricing an almost 90 per cent chance of the European Central Bank (ECB) starting its easing cycle in the first quarter of next year, a scenario that was barely contemplated just three weeks ago. There are now five quarter-point cuts fully priced in, plus an 80 per cent chance of a sixth reduction; together that would take the key rate down 150 basis points to 2.5 per cent.

While markets worldwide are betting on more rate cuts, that view gained extra traction in Europe on Tuesday (Dec 5) after Isabel Schnabel, a renowned ECB hawk, said inflation is showing a “remarkable” slowdown and that another hike in borrowing costs is “rather unlikely”. Markets have long dismissed chances of further tightening, but Schnabel had been cautioning that it was too early to rule out more hikes.

If traders are right, the ECB will be the first among major central banks to cut rates next year, and will deliver the most aggressive easing cycle. Still, some of Wall Street’s biggest names are already cautioning that expectations for cuts by central banks around the world are starting to look extended.

The Federal Reserve is expected to deliver its first move in May and lower rates by 125 basis points. And in the UK, markets are currently pricing three Bank of England quarter-point cuts starting in June, and a 30 per cent chance of a fourth move. A month ago, just two cuts were priced.

The view that major central banks will have to ease monetary conditions to support their economies next year has boosted bonds, making November a month for the record books. The yields on 10-year US and German bonds are down more than 45 basis points over the past month. The equivalent rate on gilts is down more than 30 basis points.

Schnabel’s remarks came just days after a report showed euro-area inflation slowed to 2.4 per cent, far lower than economists had anticipated and approaching the ECB’s 2 per cent target.

While effectively ruling out another rate hike, Schnabel said in reference to potential cuts that “we should be careful in making statements about something that is going to happen in six months’ time”. Her colleagues Boris Vujcic ruled them out in the near future, while Francois Villeroy de Galhau said the ECB would examine the question at some point during 2024.

That caution is also gaining traction on Wall Street, with strategists at BlackRock saying on Tuesday that they “see the risk of these hopes being disappointed”. Goldman Sachs’s strategists are meanwhile recommending options bets to counter excessive rates pricing, and Allianz chief economic adviser Mohamed El-Erian warned the Fed is losing control of its messaging.

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“I do believe the Fed is done raising rates, but I don’t think that validates what is in the markets about rate cuts next year,” El-Erian said on Tuesday. BLOOMBERG