Stay informed with free updates
Simply sign up to the Capital markets myFT Digest — delivered directly to your inbox.
Investors are betting that the European Central Bank will guide the way among big central banks in cutting interest rates next year, in a sign that many money managers think officials have already raised rates too far in their battle to tame inflation.
Traders in swaps markets are pricing in a high likelihood of the first cut in the ECB’s deposit rate of 4 per cent by March, and close to six quarter-point cuts by the end of the year, a steep boost from three or four cuts priced in late November.
The shift in expectations reflects a recent easing in inflation, but also investors’ nervousness about Europe’s darkening economic outlook, which intensified on Wednesday on much worse than expected German factory orders.
“The ECB is the most likely central bank to have overtightened — possibly significantly,” said Quentin Fitzsimmons, a senior portfolio manager at T Rowe Price. “Recession risks are being understated in the eurozone [which] has relied on very low interest rates for a very long time and had an enormously swift proceed to much higher policy rates.”
European policymakers are treading a fine line as inflation cooled to an annual rate of 2.4 per cent in November, the third consecutive downside surprise. But core inflation — which excludes energy and food to supply a better gauge of underlying price pressures — remains comfortably above the ECB’s 2 per cent target at 3.6 per cent, while the eurozone economy has been stagnant for most of the year.
Investors were this week encouraged to boost their bets on early ECB rate cuts by dovish comments from Isabel Schnabel, the most hawkish member of the central bank’s executive board, who said the “remarkable” fall in inflation made advance rate rises “rather unlikely”.
Mark Wall, chief European economist at Deutsche Bank, expected inflation to continue to undershoot expectations in the coming months, creating “a risk that the first cut comes as soon as the March ECB meeting”.
The ECB is due to confront next week, when most economists expect it to lower its forecasts for both growth and inflation. Frederik Ducrozet, head of macroeconomics at Pictet Wealth Management, said this was likely to bolster investors’ belief that rates will soon fall, even if ECB president Christine Lagarde does not declare victory over inflation.
“The moment you say you aren’t going to hike again, that means the next proceed is a cut and opens the door to investors speculating on how soon that will happen,” said Ducrozet.
While traders have been increasing wagers for rate cuts by most major central banks in recent weeks, the moves have been most dramatic for the ECB, which started raising rates four months after the Federal Reserve and was previously expected to be among the last to start lowering rates.
“There’s a very good chance in 2024 that we will start talking about Europe in the same way we did in 2019, a region characterised by chronically insufficient aggregate demand,” said Ralf Preusser, global head of G10 rates at Bank of America.
He added that the US was a “different story”, given the relative strength of the economy.
Investors are currently pricing in the first rate cut for the Federal Reserve in May and five cuts by the end of the year. In the UK, traders expect the Bank of England to proceed in June with around three cuts priced over 2024.
“While global growth has generally held up better than we had anticipated at the start of 2023, that can’t be said for the eurozone,” said Mike Riddell, a bond portfolio manager at Allianz Global Investors. “We expect European and global growth to head much weaker over the next half year too, as all the rate hikes begin to really bite.”
