BOE & ECB Interest Rate Expectations Update; October ECB Meeting Preview

Central Bank Watch Overview:

• Both the BOE and ECB are expected to tighten quickly over the coming months in an attempt to tamp down inflation ahead of recessions.
• The October ECB meeting this week is likely to see a 75-bps rate hike.
• Retail trader positioning suggests EUR/USD rates have a bullish bias while GBP/USD rates have a mixed bias.

Recession Coming? Doesn’t Matter

In this edition of Central Bank Watch, we’ll cover the two major central banks in Europe: the Bank of England and the European Central Bank. While the energy crisis has seemingly relaxed in recent weeks, the near-term economic outlook for both the UK and the Eurozone remains weak. Nevertheless, with multi-decade highs in inflation rates persisting, both the BOE and the ECB will attempt to raise rates aggressively in the coming months to tamp down inflation pressures before the economic outlook weakens further.

For more information on central banks, please visit the DailyFX Central Bank Release Calendar.

BOE Hike Odds Stay Elevated

It’s been an interesting month for the BOE, needless to say. The UK mini-budget precipitated an emergency intervention by the BOE in UK Gilt markets, which ultimately culminated with the resignation of former UK Prime Minister Liz Truss. Now that Rishi Sunak has taken over as UK Prime Minister, all appears well: UK Gilt yields are lower than where they were before the mini-budget, and the British Pound is stronger versus the Euro and the US Dollar. The lack of dysfunction may now give the BOE the runway it needs to continue with its plans to fight inflation with aggressive rate hikes in the coming months.

Bank of England Interest Rate Expectations (October 25, 2022) (Table 1)

UK overnight index swaps (OIS) are discounting aggressive action moving forward, with a 127% chance of a 75-bps rate hike in November (a 100% chance of a 25-bps hike, a 100% chance of a 50-bps rate hike, a 100% chance of a 75-bps rate hike, and a 27% chance of a 100-bps rate hike). After a likely 75-bps rate hike in November, another 75-bps rate hike is discounted in December. The BOE’s main rate is expected to rise to 4.957% by June 2023, a decline from where it was discounted two weeks ago at 5.770%.

IG Client Sentiment Index: GBP/USD Rate Forecast (October 25, 2022) (Chart 1)

GBP/USD: Retail trader data shows 54.12% of traders are net-long with the ratio of traders long to short at 1.18 to 1. The number of traders net-long is 13.08% lower than yesterday and 0.25% lower from last week, while the number of traders net-short is 13.44% higher than yesterday and 2.36% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests GBP/USD prices may continue to fall.

Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed GBP/USD trading bias.

ECB Hiking into Recession

Now that European natural gas prices have fallen back meaningfully, fears of a debilitating economic recession over the next few months have eased – though to be clear, recession is still on the horizon. Nevertheless, this reprieve may afford the ECB the opportunity to combat inflation pressures more forcefully before the end of the year, even if stagflation risks remain elevated.

EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (October 25, 2022) (TABLE 2)

Eurozone OIS are now pricing in a 92% chance of 75-bps rate hike later this week (100% chance of a 25-bps rate hike and a 100% chance of a 50-bps rate hike). Rates markets are gradual reduction in the pace of hikes thereafter, with a 50-bps rate hike discounted in December and again in February 2023. €STR, which replaced EONIA, is now priced for at least 200-bps more hikes through September 2023, where the ECB’s main rate will peak at 2.839% (currently 0.75%).

IG Client Sentiment Index: EUR/USD Rate Forecast (October 25, 2022) (Chart 2)

EUR/USD: Retail trader data shows 48.48% of traders are net-long with the ratio of traders short to long at 1.06 to 1. The number of traders net-long is 6.63% lower than yesterday and 12.19% lower from last week, while the number of traders net-short is 8.60% higher than yesterday and 8.30% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.

— Written by Christopher Vecchio, CFA, Senior Strategist