Central Bank Watch Overview:
- Bank of England rate hike odds are stagnating: the 2022 terminal rate is down from 2.176% to 2.099% over the past three weeks.
- Now that several European Central Bank policymakers have suggested a rate hike is possible in July, rates markets are pricing in 100-bps of tightening through the end of 2022.
- Retail trader positioning suggests both EUR/USD and GBP/USD rates have a bullish bias.
Divergence Between the Central Banks
In this edition of Central Bank Watch, we’ll cover the two major central banks in Europe: the Bank of England and the European Central Bank. There’s been somewhat of a divergence between the BOE and ECB in recent weeks, where the former has indicated that it will not accelerate its pace of rate hikes while the latter has given clear signals that it will move sooner than the previously suggested timeline. This narrowing expectations gap between the BOE and the ECB may soon spark a change of fortune for EUR/GBP, EUR/USD, and GBP/USD rates.
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BOE Hike Odds Stall
Bank of England policymakers are seemingly at odds with the UK government, with the central bank warning of a significant negative impact to the cost of living in the UK while Prime Minister Boris Johnson handwaves away any such concerns. But as understood at the May BOE rate decision, the Monetary Policy Committee seems equally concerned with the downside risks to growth as it does with the upside risks to inflation, thus giving no reason for traders to believe that the BOE will accelerate their pace of rate hikes during 2022.
Bank of England Interest Rate Expectations (May 17, 2022) (Table 1)
UK overnight index swaps (OIS) are discounting a 133% chance of a 25-bps rate hike in June (a 100% chance of a 25-bps hike and a 33% chance of a 50-bps hike). Rates markets are still pricing in a 25-bps rate hike at every meeting for the rest of 2022. And while that seems aggressive, it’s a relatively slower pace than what was expected at the end of April: the expected terminal rate for the BOE in 2022 now sits at 2.099%, down from 2.176% less than three weeks ago.
IG Client Sentiment Index: GBP/USD Rate Forecast (May 17, 2022) (Chart 1)
GBP/USD: Retail trader data shows 71.23% of traders are net-long with the ratio of traders long to short at 2.48 to 1. The number of traders net-long is 16.25% lower than yesterday and 19.35% lower from last week, while the number of traders net-short is 20.50% higher than yesterday and 32.18% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests GBP/USD prices may continue to fall.
Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current GBP/USD price trend may soon reverse higher despite the fact traders remain net-long.
ECB Buckles Under Pressure
How quickly things can change. At their meeting in late-April, the European Central Bank suggested that an end to stimulus efforts in 3Q’22 remains the most likely course of action, with rate hikes following soon after. But as the Russian invasion of Ukraine has pressed on, inflation has become more entrenched, demanding a re-think by various Governing Council members.
Last week, ECB President Christine Lagarde said that she would support a 10-bps rate hike in July, followed by similar comments by ECB Governing Council member Mario Centeno today. ECB Governing Council member Klaas Knot went a bit further, suggesting that a 50-bps rate hike should be on the table.
What this means is that the gap between the ECB and rate hike expectations has closed, with the market winning out. It now appears that the ECB will end asset purchases at their next meeting in June, paving the way for policy tightening in July. More importantly, because the ECB has buckled under inflation pressures, markets are now predicting that a more rapid pace of rate hikes will transpire over the course of 2022.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (May 17, 2022) (TABLE 2)
Eurozone OIS are now discounting a 20-bps rate hike in July (266% chance), a dramatic elevation from the more modest pricing back at the end of April. €STR, which replaced EONIA, is now priced for 100-bps of hikes through the end of 2022, up from 60-bps at the end of April. While the ECB is still trailing behind other major central banks in terms of expected rate hikes, the expectations gap has closed considerably, which should help insulate the Euro from more significant downside (so long as the rate hike pricing remains elevated).
IG Client Sentiment Index: EUR/USD Rate Forecast (May 17, 2022) (Chart 2)
EUR/USD: Retail trader data shows 68.78% of traders are net-long with the ratio of traders long to short at 2.20 to 1. The number of traders net-long is 10.78% lower than yesterday and 8.33% lower from last week, while the number of traders net-short is 20.02% higher than yesterday and 8.44% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EUR/USD prices may continue to fall.
Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current EUR/USD price trend may soon reverse higher despite the fact traders remain net-long.
— Written by Christopher Vecchio, CFA, Senior Strategist