Traders Start Pricing In Chance Of ECB Rate Cut Late Next Year

Money markets in the euro zone have started pricing in a chance of an ECB rate cut late next year, as traders bet the bank may end up overtightening monetary policy by delivering a series of big rate hikes.

Last week the European Central Bank lifted its deposit rate by an unprecedented 75 basis points (bps) to 0.75% to "frontload" policy tightening and get a hold of soaring inflation. The bank implied rate rises could continue into early 2023 even as the bloc braces for recession.

Since that meeting, traders have ramped up their bets on larger moves. Money markets now price in around 70 bps of hikes in both October and December. They see rates peaking at around 2.7% in mid-2023, according to ICAP data provided by Refinitiv.

Yet because of those steeper expectations, traders have also started to bet the ECB will then start cutting rates -- money markets see rates at around 2.6% by February 2024.

Before last week's ECB meeting, an additional 90 bps of hikes were priced in by year-end and rates were seen peaking at around 2.2% and then holding steady.

GRAPHICS: Traders start betting on ECB rate cut:

"With the ECB in front-loading mode and taking a leaf out of the Fed's book I expect further inversion," said Antoine Bouvet, senior rates strategist at ING, referring to a rate cut being priced in.

The moves in euro zone money markets echo what has been happening in the United States.

There, the Federal Reserve has also been frontloading rate hikes, delivering a combined 200 bps of increases since May.

Fears that aggressive rate hikes will push the U.S. economy into recession have led traders to price in some 50 bps of Fed rate cuts next year after they peak above 4% in March.

For the euro zone, a Reuters poll expects the ECB's deposit rate to peak at 1.50% and hold there, but investment banks Nomura, BofA and German insurer Allianz are among those already predicting rate cuts next year or in 2024.

The shift since last week implies traders pricing in over a 40% chance of a 25 bps cut by February 2024. But Piet Christiansen, chief analyst at Danske Bank, sees a one-off rate cut as unlikely, and instead says it reflects the market pricing a small probability of multiple 25 bps rate cuts.

"I think the hurdle is quite high and also because inflation is going to print above 2% until spring 2024 in Europe so politically, can (ECB chief Christine) Lagarde cut rates with inflation above 4%? I'm not sure," he added.