Updated interest rate forecasts from the BOE and the ECB

Overview of central bank supervision:

  • Multi-decade highs in inflationary pressures are expected to prompt further rate hikes by the Bank of England and the European Central Bank in the months ahead.
  • However, growing recession fears in the Eurozone and the UK have market participants wondering how long rate hike cycles will continue.
  • retail trader positioning suggests EUR/USD rates and GBP/USD rates have a short-term bearish bias.

More rate hikes

In this edition of Central Bank Watch, we will discuss the two major European central banks: the Bank of England and the European Central Bank. The Eurozone and the UK have continued to face high inflation rates for several decades, making it likely that further rate hikes will occur on the immediate event horizon. But with growing concerns about growth in both regions, questions remain about how long rate hike cycles will last beyond 2022.

For more information on central banks, please see the DailyFX central bank release schedule.

BOE Hike Odds Edge Higher

The risk of stagflation is increasing for the UK. The latest UK jobs report showed a slowing labor market, while UK inflation figures are expected to rise further. For now, the BOE remains determined to quell price pressures, meaning growth is likely to weaken further from here. At the moment, the rates markets are now the most aggressive of all year in terms of the odds of a BOE hike.

Bank of England interest rate expectations (August 16, 2022) (Table 1)

UK Overnight Index Swaps (OIS) discount an 84% chance of a 50bps rate hike in September (a 100% chance of a 25bps hike and a chance 84% of an increase of 50 basis points). Rates markets are pricing in a further 50 basis point rate hike in November and are pricing in a 25 basis point rate hike in December. The expected terminal rate for the BOE in 2022 now stands at 3.002%, down from 2.888% in mid-July. A tightening beyond this level in 2023 is however questionable; a single additional rate hike of 25 basis points is expected until 1Q’23.

IG Customer Confidence Index: GBP/USD Rate Forecast (August 16, 2022) (Chart 1)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

GBP/USD: Retail trader data shows 73.37% of traders are net long with a ratio of long to short traders of 2.76 to 1. The number of net long traders is 4.82% higher than that of yesterday and 9.17% higher than last week, while the number of net-short traders is 1.92% lower than yesterday and 23.65% lower than last week.

We generally take a contrarian view of crowd sentiment, and the fact that traders are net buyers suggests that GBP/USD prices may continue lower.

Traders are sharper than yesterday and last week, and the combination of current sentiment and recent shifts gives us a stronger contrarian GBP/USD-bearish trading bias.

Anti-fragmentation efforts are working, for now

The ECB’s difficult balancing act of raising interest rates to combat decades-long spikes in price pressures while preventing fragmentation in sovereign bond markets (by preventing peripheral debt yields from s ‘widen compared to their base counterparts) has proven effective so far. But concerns about growth continue to grow as Eurozone energy stocks remain depressed ahead of the winter months. It looks increasingly likely that the ECB will only be able to raise rates a few more times before the pendulum swings towards a greater focus on preventing a significant economic downturn.

EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (August 16, 2022) (TABLE 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

Eurozone OIS are now pricing in an 81% chance of a 50bp rate hike in September (100% chance of a 25bp rate hike and 81% chance of a 25bps rate hike) of 50 bps), in line with expectations of the past few months (especially before the July ECB meeting, where a tightening of 100 basis points was expected until September; the July ECB meeting allowed a rise rates of 50 basis points). The €STR, which replaced the EONIA, is now priced for further hikes of 105 basis points until the end of 2022. The ECB rate hike cycle is expected to slow rapidly thereafter, with a single rate hike of 25 basis points discounted until 2Q’23.

IG Customer Confidence Index: EUR/USD Rate Forecast (August 16, 2022) (Chart 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

EUR/USD: Retail trader data shows that 64.51% of traders are net long with a ratio of long to short traders of 1.82 to 1. The number of net long traders is 7.79% higher than that of yesterday and 25.35% higher than last week, while the number of net-short traders is 3.52% lower than yesterday and 27.26% lower 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.

Traders are sharper than yesterday and last week, and the combination of current sentiment and recent shifts gives us a stronger contrarian EUR/USD-bearish trading bias.

— Written by Christopher Vecchio, CFA, Senior Strategist

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