Draghi Triggers Money Market U-Turn

  • Eonia forwards signal rate increases in July, December of 2018
  • Bund yields break above 0.5% to highest level since early 2016

Mario Draghi has forced money markets into an about-turn.

Interest-rate forwards now price in two increases of 10 basis points each in the European Central Bank’s deposit rate next year, compared with none as recently as mid-June. Expectations for monetary tightening had in fact receded through most of the last two months. The first 10-basis-point boost may come in July 2018, followed by another in December, lifting the ECB rate to minus 20 basis points, overnight Eonia forwards suggest.

The shift in policy expectations came after ECB President Draghi said last week that deflationary forces in the region had been replaced by reflationary ones, fueling speculation that the central bank will announce a move to taper monetary stimulus as early as this autumn. That helped fuel a global bond-market rout this week, with yields on German 10-year bunds surging to 0.58 percent, the highest level since January 2016.

“Our call is for a rate hike in the second half of 2018 but where the market has got to now, it doesn’t feel like big overshoot,” said Andy Chaytor, head of European rates strategy at Nomura International in London. The euro-area economy has seen significant improvement, so “we should be wary of saying things are far too aggressive” in the market, he said.

At the ECB’s June 8 meeting, Draghi had warned that Europe was not generating enough inflation, adding to speculation that the central bank may delay the start of stimulus tapering or prolong its duration. The annual pace of euro-area price growth slowed in June to 1.3 percent, but still beat economist estimates. That compares with the ECB’s goal of an inflation rate below but close to 2 percent.

— With assistance by Stephen Spratt

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