Some of the biggest money managers in Europe say traders are wrong to bet the European Central Bank is done hiking interest rates.
As a net energy importer, the region is particularly exposed to rising prices if the crisis in the Middle East escalates, and markets are underestimating the possibility of additional tightening in response, according to Legal & General Investment Management, Vanguard Asset Management Ltd and Robeco Groep. That leaves short-maturity government bonds particularly vulnerable.
The view clashes with swaps pricing that shows a pause from the ECB virtually baked in this week — and only a 10% chance of a 25 basis-point hike at a subsequent meeting. In the US, swaps show a 40% chance of another quarter-point hike from the Federal Reserve.
“Europe is of greater vulnerability here than any other developed-market bloc,” said Christopher Jeffrey, head of rates and inflation strategy at Legal & General, which has £1.3 trillion ($1.6 trillion) in assets under management. “The ECB is the central bank that could feel the need to overshoot.”
At the same time, ECB President Christine Lagarde and colleagues would need to weigh the economic impact of a hike carefully, even if energy prices extend their climb. Italy’s debt load makes the EU’s third-biggest economy especially fragile in the face of tighter policy.
Fears of a wider conflagration since Hamas’s Oct. 7 attack on Israel have sent Brent crude up more than 10%. Disruptions to key shipping routes like the Panama Canal and extreme weather playing havoc with the supply of food staples are adding to the factors that could keep European inflation prints hot.
The ECB’s single mandate of price stability also makes Europe’s policy makers more likely to hike in the face of rising energy costs. Their counterparts in the Fed are charged with promoting maximum employment as well keeping prices under control.
Ales Koutny, head of international rates at Vanguard agrees with market pricing suggesting the ECB will keep rates on hold on Thursday, but says traders are too complacent over the chance of more tightening in the coming months. The firm oversees a total of $1.9 trillion in actively managed fixed-income assets globally.
“The market is underpricing the chance of another hike from the ECB,” said Koutny. “It was the same with the Fed,” until last week.
One of the arguments in favor of a pause in hikes is Italy’s fiscal situation, which deteriorated as growth faltered. Additional tightening would weigh on activity and could push the nation’s risk premium even higher, risking a debt crisis.
ECB Governing Council member Gabriel Makhlouf said earlier this month Italy’s bond-yield spread over peers is “absolutely something” officials “will be very focused on.” The gap between Italy and Germany’s 10-year bond yields recently breached 200 basis points, a widely watched level.
“With the euro-area economy already struggling and BTP-Bund spreads having widened sharply, the ECB is probably much closer to its pain threshold than the Fed,” Commerzbank AG rates strategists led by Christoph Rieger wrote. They predict the ECB’s rates are at their peak.
Read more: ECB’s Peak Rates to Endure Despite Economic Perils, Survey Shows
But those who believe the hikes are not over highlight other factors in place. Colin Graham, head of multi-asset strategies at Robeco, said extra stimulus measures from China will also spur fresh bouts of price pressure in the region.
“We definitely think the ECB should raise rates more,” Graham said. “Inflation is not under control yet.”
--With assistance from Aline Oyamada and James Hirai.
