Rates Spark: Drawing a line under EUR rates

European Central Bank (ECB) officials are making full use of the last days before their pre-meeting quiet period starts this Thursday. There appear to be little appetite to deviate from the guidance given in December that the February meeting will see another 50bp hike. Whether the same holds for the March meeting is less certain, but only a couple of national central bank governors came out in favour of a more gradual pace of increases going forward, understood to mean 25bp increments.

We wouldn’t overplay the importance of ECB guidance more than one meeting ahead

In a sense, we wouldn’t overplay the importance of ECB guidance more than one meeting ahead. The March meeting will feature a new set of staff economic forecast which will go a long way towards shaping policy decision. Our base case is that, out of consistency at least, President Christine Lagarde will repeat the March 50bp guidance at next week’s meeting, but we think market direction is more likely to be dictated by economic releases, for instance today’s PMIs, and especially the components related to inflation.

What happens after that is the object of less discussion but is of no less importance. The hawks are already positioning for hikes at the May and June meetings although few doubt that, by that point, more dovish members will have managed to push for a downshift to 25bp increments. Similarly, there has been comparatively fewer pot shots taken at market expectations of up to 100bp worth of rate cuts by end-2024. There is no doubt in our mind that pricing policy easing this far from the end of the tightening cycle is presumptuous, even if we assume that markets are right about the amount of Fed cuts to be delivered by that time.

We suspect that short-term longs are likely to take profit before next week’s Fed and ECB meetings

All these considerations have acted as a barrier to 10Y Bund yields crossing below 2%, and for 10Y EUR swaps approaching 2.5%. We identified both levels as the likely bottom of the range for EUR rates this year and we think ECB policy will be instrumental in enforcing it, at least before the midway point of 2023 is reached. Meanwhile, we suspect that short-term longs are likely to take profit before next week’s Fed and ECB meetings, and a rebound in natural gas prices has also pressured rates higher.