European Central Bank: Hawkish ECB pricing supports Euro – MUFG

Lee Hardman at MUFG notes that Euro-zone yields have climbed to fresh year-to-date highs ahead of the European Central Bank (ECB) meeting, with markets pricing 2–3 further rate hikes and almost fully discounting another move in September. The report aligns with Hardman's forecast for one final September hike, while warning that sustained higher energy prices could increase risks of additional tightening and weigh on Euro-area growth.

Rising yields and ECB pricing

"In response to rising energy prices, market participants have been moving to price in more hawkish expectations for major central banks including the ECB and Fed resulting in short-term yields rising to fresh year-to-date highs. The euro-zone rate market is now pricing in two to three further ECB rate hikes in the year ahead while the US rate market is pricing in around two Fed hikes over the same period. Short-term yields have risen more recently in Europe than in the US resulting in yield spreads moving against the USD."

"Another hike as soon as the following policy meeting in September is almost fully priced in. It fits with our own forecast for one final hike in September, although we acknowledge that the risk of an additional hike later this year would is increasing if higher energy prices are sustained during the second half of this year."

"We see little scope today for President Lagarde to push back strongly against market expectations for multiple rate hikes given inflation risk are increasing. Higher energy prices will add to downside risks for growth in the euro-zone as well. Like in the US, the euro-zone economy has held up better than expected so far to the energy price shock providing some reassurance."