Rates Spark: Navigating Uncertainty in the European Central Bank's Monetary Policy
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Rates Spark: Enough out there to nudge market rates higher
Weak economic data dents the European Central Bank’s ability to push rates up. Even if July and September hikes were fully priced in, Bund and swap will find it hard to rise above the top of their recent range. Direction is far from clear, but our preference is to position for upward pressure on yields.
Soft economic data dents ECB hawkish rhetoric
For financial markets, a flurry of weak economic activity data – most prominently in the manufacturing sector such as yesterday’s German factory orders and tofay's industrial production – sits awkwardly with the European Central Bank's (ECB) message that more monetary tightening is needed.
The pre-meeting quiet period starts tomorrow, making today the last opportunity to skew investor expectations but markets pricing a 25bp hike at this meeting are unlikely to move much. Another important clue as to future policy moves will be in the staff forecasts released at the same time as next week’s policy decision.
The 2025 headline and core inflation projections at the March meeting stood at 2.1% and 2.2% annualised, above the ECB’s target and a clear signal that more tightening is needed – even above and beyond the path for interest rates priced by the market in late February.
Dovish-minded investors can point to a decline in oil and gas futures since the March meeting, as well as a downtick in consumer inflation expectations in the most recent survey released yesterday. Will this be enough for the ECB to no longer signal that it has ‘more ground to cover’? Probably not, but markets may not care. The focus among hawks is squarely on core inflation and the modest decline from a 5.7% peak in March to 5.3% in May hasn’t been met with much relief by the Governing Council, but it has pushed euro rates down relative to their dollar peers.
