Nordea said ECB officials including Isabel Schnabel, Philip Lane, Olli Rehn and Yannis Stournaras have stepped up signalling of a June policy rate rise, and potentially further moves, with references to maintaining credibility. The bank pointed to concern that higher energy prices could spill over into broader inflation and wages, and argued markets are underestimating the risk of a fuller hiking cycle if second-round effects take hold. It added that the EUR front end rallied last week despite the shift in messaging.
Schnabel cited a higher oil futures curve as implying a more persistent shock and pointed to firmer non-energy price pressures, referencing a sharp rise in firms’ selling price expectations and higher medium-term household inflation expectations. Lane also anticipated an upward revision to staff inflation forecasts at the June meeting while acknowledging the drag on the economy, and he echoed the spillover risk from energy into wider prices. Rehn and Stournaras framed a rate increase as a credibility measure, with Nordea noting the ECB’s first 2022 hike came only after inflation had exceeded 8%.
ECB Signals And Market Response
We see a growing chorus of ECB officials signaling a rate hike this month to protect their credibility. Key figures are openly discussing the need to act pre-emptively against inflation spilling over from energy to the broader economy. Yet, short-term interest rate markets seem too complacent about the potential for a more aggressive hiking cycle.
This view is reinforced by last week’s flash CPI data for the Eurozone, which showed inflation unexpectedly accelerating to 3.1% in May. More importantly, core inflation, which strips out volatile energy prices, also ticked up to 2.9%, suggesting these price pressures are becoming embedded. This is exactly the kind of “second-round effect” that officials have been warning about.
The memory of being late to hike in 2022, when inflation surged past 8%, is clearly influencing the current debate. Policymakers are determined not to repeat that mistake, which is why even traditional doves are now arguing for a “credibility hike.” We believe this makes a move at the June 11th meeting almost a certainty, regardless of any short-term weakness in activity data.
Strategy Implications And Euro Outlook
Consequently, we see value in positioning for a steeper front-end of the Euro yield curve. Futures contracts, such as those on the 3-month EURIBOR, appear to be underpricing the risk of at least two hikes by the end of the third quarter. Options strategies that benefit from rising short-term rates, or higher volatility in rates, should be considered.
This policy divergence should also lend support to the Euro, especially against currencies where the central bank is perceived to be pausing. As of today, options markets are showing relatively low implied volatility for EUR/USD, suggesting that long-Euro positions can be established with attractive risk-reward profiles. We anticipate a move back towards the 1.10 level if the ECB delivers a hawkish message this month.
