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Central Bank Watch: BOE & ECB Interest Rate Expectations Update

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

Christopher Vecchio, CFA, Senior Strategist
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Central Bank Watch Overview:

  • Bank of England rate hike odds have risen again: the 2022 terminal rate is back up to 2.450% from 2.099% over the past three weeks.
  • The European Central Bank is very likely to end its asset purchase program this week, paving the way for a rate hike in July.
  • Retail trader positioning suggests both EUR/USD and GBP/USD rates have a mixed bias.

Convergence Among the Major 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 has been a consistent theme emerging across developed economies: strong labor markets, sluggish growth, and multi-decade highs in inflation rates. Most major central banks are now acting in unison, suggesting that interest rate increases will follow on a consistent basis over the coming months. Both the BOE and ECB find themselves in this camp.

For more information on central banks, please visit the DailyFX Central Bank Release Calendar.

Reignited BOE Hike Odds

Despite BOE policymakers signaling at the May rate decision that they are equally concerned with downside risks to growth as they are with upside risks to inflation, rates markets have had a rethink in recent weeks. Since mid-May, amid signs that the rises in food and energy prices won’t relent anytime soon, rates markets have dragged forward BOE rate hike expectations for the remainder of 2022, helping provide a tailwind for the British Pound.

Bank of England Interest Rate Expectations (June 7, 2022) (Table 1)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

UK overnight index swaps (OIS) are discounting a 117% chance of a 25-bps rate hike in June (a 100% chance of a 25-bps hike and a 17% 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. But there has been a subtle shift: it’s a faster pace than what was expected in mid-May: the expected terminal rate for the BOE in 2022 now sits at 2.450%, up from 2.099% approximately three weeks ago.

IG Client Sentiment Index: GBP/USD Rate Forecast (June 7, 2022) (Chart 1)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

GBP/USD: Retail trader data shows 65.08% of traders are net-long with the ratio of traders long to short at 1.86 to 1. The number of traders net-long is 0.64% lower than yesterday and 2.22% lower from last week, while the number of traders net-short is 4.94% lower than yesterday and 1.65% 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.

Positioning is more net-long than yesterday but less net-long from last week. The combination of current sentiment and recent changes gives us a further mixed GBP/USD trading bias.

Neither a Question of ‘If’ or ‘When,’ But ‘How Much?’ for the ECB

The gap between the ECB and other major central banks’ rate hike odds that defined much of 2022 continues to close. Rates markets continue to price in the first rate hike in July, after the ECB announces an end to its asset purchase program at its June meeting this week (when new Staff Economic Projections (SEP) are released).Elevated ECB rate hike odds continue to be reflected in the short-end of various European sovereign debt yields. It remains the case that rising short-end bond yields should prove supportive of the Euro.

EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (June 7, 2022) (TABLE 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

Eurozone OIS are now discounting a 25-bps rate hike in July (252% chance), more than what most ECB policymakers have been suggesting in recent weeks (a 10-bps rate hike). €STR, which replaced EONIA, is now priced for 127-bps of hikes through the end of 2022, up from 60-bps at the end of April. The expectations gap between the ECB and other major central banks 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 (June 7, 2022) (Chart 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

EUR/USD: Retail trader data shows 58.44% of traders are net-long with the ratio of traders long to short at 1.41 to 1. The number of traders net-long is 3.65% lower than yesterday and 3.84% higher from last week, while the number of traders net-short is 0.90% lower than yesterday and 0.77% lower 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.

Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.

--- Written by Christopher Vecchio, CFA, Senior Strategist

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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