Traders Flip to Bet on ECB Hike as Inflation Upends Rate View

In a span of days, the market has completely changed its view what the European Central Bank is likely to do on Thursday, highlighting just how much uncertainty surrounds the decision.

(Bloomberg) — In a span of days, the market has completely changed its view what the European Central Bank is likely to do on Thursday, highlighting just how much uncertainty surrounds the decision.

Money markets are now pricing in a 68% change that the ECB raises interest rates by a quarter of a percentage point. The view has changed rapidly in recent weeks as evidence builds that Europe is facing persistent inflation that’s been made worse by soaring energy prices. 

At the start of September, traders were firmly in the camp that the ECB would hold rates steady to keep economic growth in tact, with markets reflecting 20% odds of a hike.   

But in the face of reports that the ECB now expects inflation to stay above 3% next year, analysts say it’ll be increasingly difficult for the central bank to stand pat, especially as the euro starts to buckle. Last week, Dutch Governor Klaas Knot told Bloomberg that investors were “maybe” underestimating the likelihood of an increase in borrowing costs.

Read More: Germany to Predict 2023 Contraction in Updated GDP Forecast

The ECB is in a “lose-lose” situation given the stickiness of inflation, said Alberto Gallo, chief investment officer at Andromeda Capital Management Ltd. in a Bloomberg Television interview. 

“Markets are right to price another hike from the ECB,” he added. “But it might turn out to be a policy error.”

Even within the ECB, the decision is said to be a cliffhanger. The decision is so finely balanced that officials going to the gathering starting Wednesday are in suspense too, people familiar with the matter said earlier this week.

Bonds slipped on Wednesday, led by the short-end of the curve. The German two-year yield — among the most sensitive to monetary policy — rose four basis points to 3.17%, the highest level since mid-August. Italian government bonds also fell, sending the 10-year yield 5 basis point higher to 4.45%.

What Bloomberg Economics Says…

“The Governing Council is likely to conclude that underlying inflation isn’t decelerating rapidly enough. The headline reading has been higher than the ECB forecast, inflation expectations remain elevated and risks are probably still skewed somewhat to the upside.”

— David Powell and Maeva Cousin. For full preview, click here

The sharp move in ECB rate bets came immediately after Reuters reported on the central bank’s inflation forecast. The central bank’s two-day policy meeting starts on Wednesday and a rate decision is due Thursday at 2:15 p.m. in Frankfurt. 

It has “definitely spurred the front-end pricing, where markets were rather complacent on a no hike scenario,” said Pooja Kumra, senior European rates strategist at Toronto-Dominion Bank. She said it’s a very close call, but ultimately expects the ECB to hold rates.

Among traders, there’s a guessing game over what the ECB will do. While most market participants believe the central bank is near the end of monetary tightening after delivering nine straight rate increases, there’s a debate about when it’ll exactly finish. 

Meanwhile, strategists are increasingly pessimistic on the currency as Europe faces another winter of high energy prices and Germany’s industrial engine slows. The currency has fallen for eight consecutive weeks to lose over 4% from a peak in July. Hedge funds dumped nearly 90% of their net long euro positions in August.

“Markets have doubted the ability of the ECB to hike this week,” said Francesco Pesole, an FX strategist at ING Bank NV. “The best President Lagarde can do for the euro is to offer a lifeline.”

–With assistance from Dayana Mustak.

(Adds additional context. A previous version of this story corrected TD’s interest-rate call in the fourth paragraph.)

More stories like this are available on

©2023 Bloomberg L.P.