Traders curb bets for ECB hikes to less than a quarter point

[BRUSSELS] Traders are reappraising the scope for the European Central Bank (ECB) to lift interest rates as sliding oil prices reduce the risks of sticky inflation. 

For the first time since April, markets are no longer pricing in a full quarter-point rate increase that would take the key rate to 2.5 per cent before the end of 2026. Such a hike was baked in two weeks ago, before ECB policymakers raised the deposit rate to 2.25 per cent. 

It’s a sharp turnaround from the early days of the US-Iran war, when traders rushed to price almost four hikes on the expectation that policymakers would need to act aggressively to curb rising prices amid the global energy shock.

The reduction in those bets reflects this week’s drop in oil prices to pre-war levels following the signing of an interim peace deal. That eased pressure on euro-area prices with the two-year inflation swap gauge back below 2.2 per cent from more than 3 per cent in April.

“It makes sense for the market to test expectations for a hike,” said Evelyne Gomez-Liechti, a multi-asset strategist at Mizuho International Plc. At the same time, she noted that some ECB members remain cautious and haven’t given up on the need to raise rates.

The pressure on policymakers to contain price growth should ease further if next week’s inflation figures come in as expected. Economists are predicting the year-on-year rate will slow to 3.1 per cent in June from 3.2 per cent a month earlier.

An ECB survey published on Friday (Jun 26) showed inflation expectations among euro-area consumers for the next year fell significantly in May.

Strategists at Deutsche Bank recommend positioning for fewer ECB interest rate hikes by year-end, noting lower oil prices have led to downward revisions in inflation forecasts which may allow policymakers to keep the deposit rate steady at 2.25 per cent. 

German 10-year yields were down one basis point on Friday at 2.85 per cent, the lowest since March 10. Yields reached a 15-year peak above 3.2 per cent last month.

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Bets on fewer rate increases due to the fall in energy prices are not confined to the euro area. 

A similar picture is emerging in the UK where swaps price about an 85 per cent chance of a quarter-point hike this year, down from as many as four hikes seen back in March. In the US, traders envisage a 25 per cent chance of two hikes by year-end, down from almost 80 per cent seen on Monday. BLOOMBERG