Update on interest rate expectations of the BOE and the ECB
Overview of central bank supervision:
- The BOE appears poised to move forward with several rate hikes in 2022, as rate markets are currently forecasting at least four moves by December.
- There remains a mismatch between the ECB’s rhetoric and market prices, as policymakers continue to suggest that no rate hike will come in 2022.
- Retail trader positioning suggests that the EUR / USD and GBP / USD rates have bullish trading short-term bias.
The discomfort spreads
In this edition of Central Bank Watch, we’ll cover the two main central banks of Europe: the Bank of England and the European Central Bank. The start of 2022 produced significant moves in global bond markets as traders expect slight economic fallout from the COVID-19 omicron variant amid persistently high inflationary pressures. And while that may mean a more aggressive Bank of England over the course of the year, there is a growing mismatch between what the market expects from the European Central Bank and what the ECB says it is going to do.
For more information on central banks, please see the DailyFX central bank release schedule.
UK economy ready for treks
The last BOE policy meeting in 2021 produced a 15 basis point rate hike, which surprised traders as rate markets were expecting about a 50% chance of a hike. But with UK inflation rates at their highest level in a decade and the mounting evidence that the labor market is improving steadily, BOE policymakers and rate markets believe that further policy tightening is to come. While the BOE has been calm so far in 2022, there is reason to believe activity will pick up in the coming weeks ahead of the first meeting of the year in February.
Bank of England interest rate expectations (January 12, 2022) (Table 1)
As was the case last month, rate markets view February 2022 as the most likely time of year for the next rate hike, with an 85% chance of a 25 basis point rate hike; this is an increase from 66% in mid-December. In addition, interest rate markets anticipated a fourth rate hike in 2022, up from three in mid-December. The timing of the BOE’s next rate hike aligns perfectly with the release of the Monetary Policy Committee’s next version of the Quarterly Inflation Report (QIR).
IG Client Sentiment Index: GBP / USD rate forecast (January 12, 2022) (Chart 1)
GBP / USD: Retail traders data shows that 40.42% of traders are net long with a ratio of short / long traders of 1.47 to 1. The number of net long traders is 12.60% lower than that of yesterday and 20.88% compared to last week. while the number of net-short traders is 11.76% higher than yesterday and 21.30% higher than last week.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net short suggests that GBP / USD prices may continue to rise.
Traders are even sharper than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger GBP / USD bullish countercurrent trading bias.
Someone is wrong
ECB policymakers have been beating the same drum for several months: no rate hike is expected in 2022. The last policy meeting in 2021 noted that the Governing Council estimated that “Monetary accommodations are still necessary for inflation to stabilize at the 2% inflation target in the medium term. “ ECB President Christine Lagarde called the current rise in inflation a “bump”. More recently, Olli Rehn, member of the Governing Council of the ECB, stated that “supply side problems do not yet lead to sustained inflation unless wage inflation is triggered sharply,“ while noting that wage inflation has not been triggered strongly and that higher inflation is therefore likely to decline.
INTEREST RATE ANTICIPATIONS OF THE EUROPEAN CENTRAL BANK (January 12, 2022) (TABLE 2)
While the ECB has repeatedly signaled that it will not give up its accommodative policy efforts anytime soon, market prices around the ECB’s projected rate path may still be too hawkish. Interest rate markets are now banking on a 98% chance that the ECB’s first rate hike will occur in October 2022, up from 67% in mid-December. The current euro rally could offer a selling opportunity, as the odds of an ECB rate hike are expected to fall again in 2022.
IG client sentiment index: forecast for the EUR / USD rate (January 12, 2022) (Chart 2)
EUR / USD: Retail traders data shows that 52.38% of traders are net long with a ratio of long / short traders at 1.10 to 1. The number of net long traders is 3.77% lower than that of yesterday and 6.99% compared to last week. while the number of net short traders is 15.41% higher than yesterday and 19.23% higher than last week.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net long suggests that EUR / USD prices may continue to decline.
However, traders are shorter than yesterday and compared to last week. Recent sentiment shifts warn that the current trend in EUR / USD prices may soon reverse to the upside despite traders staying net long.
— Written by Christopher Vecchio, CFA, Senior Strategist