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Christine Lagarde fuels investor bets on ECB rate rises with hawkish shift

Christine Lagarde refused to rule out raising interest rates this year in response to the European Central Bank’s “unanimous concern” about soaring prices, fuelling increased investor bets that it will raise borrowing costs several times in 2022.

The ECB president said inflation risks were “tilted to the upside” after annual consumer prices in the eurozone rose by a record 5.1 per cent in January. She backed away from earlier comments playing down the chances of the bank raising rates in 2022 because of “the situation having changed” and said it was “getting much closer” to hitting its target on inflation.

Lagarde said there was “consensus” among ECB policymakers on its decision to keep rates unchanged and to pursue a “step-by-step” reduction in bond purchases this year. But a person familiar with the council said “one or two” of its members had called for an immediate tightening of policy.

In response to Lagarde’s comments during a press conference after the ECB governing council met on Thursday, investors increased their bets that the central bank will be forced to change course and raise rates several times this year.

Konstantin Veit, portfolio manager at Pimco, said the ECB’s “hawkish message” signalled “more openness towards an earlier withdrawal of monetary policy support”.

The euro jumped to a more than two-week high against the dollar and a sell-off in eurozone bonds intensified after Lagarde declined to explicitly rule out an interest rate rise this year. The single currency was up 1.2 per cent at $1.143.

Germany’s 10-year yield, a benchmark for financial assets across the eurozone, surged to a nearly three-year high of 0.14 per cent. Traders increased their bets on higher interest rates, with markets pricing in a rise in its deposit rate from minus 0.5 per cent to minus 0.1 per cent by December after Lagarde’s press conference.

While the ECB left policy unchanged, her comments were widely interpreted as signalling a likely shift to tightening monetary policy as early as March.

Carsten Brzeski, head of macro research at ING, said Lagarde’s “hawkish backward roll” had “opened the door to a speeding up of asset purchase reductions and a rate hike this year”.

Lagarde said there had been “unanimous concern around the governing council table about the impact of inflation” on Europeans and their “day-to-day hardship of having to put up with higher prices”.

She said the ECB would stick to the “sequence” it had already announced of only raising rates after it stopped net bond purchases, adding that the council would be “gradual in whatever we do” and “not be rushed into anything”.

But she raised expectations that the ECB will again raise its inflation forecast at its next policy meeting in March, bringing it up to its 2 per cent target for the next two years and leading to a quicker removal of its stimulus than planned.

This could lead to it accelerating plans for stopping net asset purchases in preparation for the first increase in its deposit rate for more than a decade.

Frederik Ducrozet, strategist at Pictet Wealth Management, said Lagarde had delivered a “reality check” for bond markets. “The risk scenario is now clear: large upward revisions to staff projections in March, a faster tapering ending net asset purchases by the third quarter, and a rate [rise] in the fourth quarter of 2022,” he added.

Higher than expected inflation has led the US Federal Reserve and the Bank of England to shift to more “hawkish” policy stances. The BoE raised its main policy rate to 0.5 per cent on Thursday, less than two months after increasing it to 0.25 per cent, while investors are pricing in five rate rises by the Fed this year.

After the ECB press conference, Italy’s 10-year bond yields rose about 20 basis points to 1.66 per cent, their highest since May 2020. James Athey, investment director at Abrdn, said: “The ECB is opening up a potentially huge hole for Italian bonds to fall into.”

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