Traders ramp up bets on 75 basis-point ECB Sept hike, bond yields jump

Euro zone money markets moved on Monday to price in a two-thirds chance of a large 75 basis-point European Central Bank rate hike in September, as policymakers made the case over the weekend for a large move to tame inflation four times above their target.

Among the officials speaking at the Jackson Hole symposium, particularly in focus was ECB board member Isabel Schnabel, who argued that the risk is rising that long-term inflation expectations “de-anchor” from the bank’s 2% target and surveys suggest inflation is denting public trust in central banks.

Others said frontloading rate hikes would be reasonable and that the neutral rate, estimated to be around 1.5%, should be reached before the end of the year or the first quarter of 2023.

Traders on Monday priced in as much as 67 basis points of rate hikes at the bank’s Sept. 8 policy meeting, meaning they fully priced in a 50 basis-point move and a 67% chance of a 75 basis-point move, Refinitiv data showed.
That compares to a 24% chance of the larger move they priced on Friday, before a Reuters report that some policymakers wanted to discuss the bigger move pushed the odds up to 48%.

“The most important signal (from Jackson Hole) was from Schanbel who talked about the risk of inflation expectations moving above target, that the central bank would have to hike rates more violently, and that is something new,” said Jan von Gerich, chief analyst at Nordea.

As rate hike bets rose, Germany’s two-year bond yield, sensitive to interest rate expectations, rose as much as 19 basis points (bps) on the day to 1.162%, the highest since June 17.

Its 10-year yield, the benchmark for the euro area, rose as much as 15 bps on the day to 1.548%, its highest in two months.

“The ECB clearly looks with determination to frontload the hikes and this will linger on ahead of the September meeting,” said Piet Christiansen, chief analyst at Danske Bank in Copenhagen.

Ten-year yields in Italy, among the biggest beneficiaries of ECB stimulus, jumped as much as 17 bps to 3.873%, the highest since mid-June, pushing the closely-watched spread to German peers to 236 bps, the highest in a month.

“The more resolute and front-loaded these rate hikes become in the wake of weaker growth, the closer we are likely get to the point where the ECB may have to consider if TPI has to be activated,” said Rohan Khanna, strategist at UBS, referring to the ECB’s Transmission Protection Instrument.

Under the TPI, ECB will buy bonds from countries whose borrowing costs relative to Germany it sees as soaring through no fault of their own.

Arguing that the ECB skewing reinvestments from maturing bonds under its pandemic bond buying programme, a first line of defense it already deployed in June and July, wouldn’t be enough, Khanna said, “the harder the ECB pushes on the rate-hike pedal, the faster we are likely to get to 300 bps on this spread.”
Source: Reuters (Reporting by Yoruk Bahceli, additional reporting by Dhara Ranasinghe; Editing by Dhara Ranasinghe and Emelia Sithole-Matarise)