ECB Interest Rate Hike Could Reach All-Time Highs

Investors are betting that the European Central Bank (ECB) will raise interest rates to all-time highs this year, spurred on by the eurozone economy’s resilience and signs of rising inflation. As a result, swap markets are pricing an increase in the ECB’s deposit rate to 3.75 percent by September, up from the current 2.5 percent. This would match the benchmark’s 2001 peak when the ECB was still trying to shore up the value of the newly launched euro.

Recent Eurozone Data

Recent eurozone data on buoyant service-sector activity and wage demands has caused markets to revise their forecasts of interest rates upwards. ECB president Christine Lagarde said on Tuesday that the bank was “looking at wages and negotiated wages very, very closely” — an indication of concern a sharp rise in salaries this year will maintain pressure on prices as companies pass costs on to consumers. The yield on two-year German bonds, highly sensitive to changes in interest rate expectations, hit a 14-year high of 2.95 percent on Tuesday after the S&P Global purchasing managers’ index outstripped forecasts.

US and UK Interest Rates

The prospect of further substantial rate rises in the eurozone contrasts with the US and the UK, which are widely considered closer to the end of their interest rate rise cycles, having already increased borrowing costs earlier and by more than the ECB. Eurozone inflation of 8.5 percent in January compares with 6.4 percent in the US. While UK inflation remains in double digits, it has fallen faster than expected, and the country’s anemic growth outlook has diminished pressure on the Bank of England to increase rates.

Forecasts for ECB Rates

In the past week, Goldman Sachs, Barclays, and Berenberg have raised to 3.5 percent their forecasts for how much further the ECB will raise rates. Deutsche Bank on Wednesday raised its forecast to 3.75 percent. “There is a risk that inflation proves to be more persistent than is currently priced by financial markets,” Isabel Schnabel, an ECB executive board member, told Bloomberg this week. Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, forecasted ECB rates would peak at 3.5 percent but added the central bank could “still be in tightening mode by September, and that takes you close to a deposit rate of 4 percent”.

ECB Already Raised Rates

The ECB has already raised rates by an unprecedented three percentage points since last summer, and this month signaled plans for another half percentage point move in the coming months.

Related Facts

• The ECB is widely seen as one of the world’s most dovish central banks.
• US stock markets fell sharply on Tuesday as upbeat economic data prompted investors to re-evaluate how much further the Federal Reserve may raise rates.
• UK inflation remains in double digits but has fallen faster than expected.

Key Takeaways

• The European Central Bank is expected to raise interest rates substantially this year.
• Swap markets are pricing in a jump in the ECB’s deposit rate to 3.75 percent by September.
• Since last summer, the ECB has raised rates by an unprecedented three percentage points.

Conclusion

The European Central Bank is likely to raise interest rates to all-time highs this year, spurred on by the eurozone economy’s resilience and signs of rising inflation. The ECB has already raised rates by an unprecedented three percentage points since last summer, and this month signaled plans for another half percentage point move in the coming months. Markets have revised forecasts of interest rates upwards after recent eurozone data on buoyant service-sector activity and wage demands, and swap markets are pricing in a jump in the ECB’s deposit rate to 3.75 percent by September.