European Central Bank tightening expectations remain subdued – BBH

Analysts at BBH note that the European Central Bank tightening expectations remain subdued following the latest Eurozone inflation data. 

ECB may stop hiking before the Fed

“Eurozone August CPI data came in hot.  Headline came in at 5.3% y/y vs. 5.1% expected and 5.3% in July, while core came in as expected at 5.3% y/y vs. 5.5% in July.”

“Basically, disinflation has stalled out in the eurozone and so the policy debate will most likely swing to the hawks’ favor.  Indeed, Holzmann said today that the ECB may extend its tightening cycle by “another hike or two.”  Schnabel was more nuanced, noting that recent data “point to growth prospects being weaker than foreseen in the baseline scenario.  But underlying price pressures remain stubbornly high, with domestic factors now being the main drivers of inflation in the euro area.” 

Yet European Central Bank tightening expectations remain subdued.  WIRP suggest odds of a 25 bp hike stand just below 30% September 14, rise to over 50% October 26 and top out near 65% December 14.  What’s very interesting to us is that these odds have actually fallen since the start of this week, meaning that neither the higher than expected August CPI data nor hawkish ECB comments have had any impact on ECB expectations whatsoever.  Market chatter regarding stagflation risks is picking up.  If this dynamic is sustained, it would be a game-changer for the euro.  Lastly, we stress again that the ECB may stop hiking before the Fed does and we don’t think the markets have priced this risk in yet.”