Rates Spark: Markets gain confidence about another ECB cut

With the eurozone flash CPI set to show a 2% headline rate, in line with the European Central Bank’s target, and oil prices having calmed over the past few days, ECB officials can feel a little more at ease. Exchange rate dynamics as a Fed discount builds can even provide the room and reason to deliver another rate cut further down the line amid a still sluggish near-term growth outlook. We hope to hear more about the ECB’s current thinking at the sidelines of this week’s central bank forum in Sintra, Portugal.

Over the past week, the markets’ ECB rate cut discount for the near term has come down slightly, though still clearly centred around a 1.75% terminal rate. However, the market is already anticipating higher rates beyond the middle of next year. There is still a trade deal that needs to be finalised for markets to find more conviction in that view, but headlines of late seem to suggest more progress despite the noise that the US President still injects. Should the outlines become clearer, that would allow longer EUR rates to set their sights on the impact of the EU and German spending plans. The 10y EUR swap rate would then start drifting beyond 2.6% where we still eye a long run fair value level of close to 3%.