MFS: Doubts over market expectations of a further three ECB rate rises
The European Central Bank is set to raise interest rates to 2.5% on Thursday. But Peter Goves, Global Head DM Fixed Income Strategy Research at MFS, has his doubts as to whether the market’s expectation of a further three rate rises will actually materialise.
'We expect the ECB to raise the deposit rate by 25bp this week, taking the deposit rate to 2.50%, in line with consensus. The hike has been well telegraphed by recent Governing Council comments and the July Accounts (which baked in “further tightening” and where some members would already have supported a move).
There was also a sense in the Accounts that a pause last time did not necessarily mark the end of the cycle. The case for a hike rests on headline inflation still above target, resilient activity data, and persistent upside risks from energy markets, particularly gas prices. With the outcome effectively priced, the meeting should be more about the tone on future tightening than the September decision itself in our view.
With this in mind, we note that core inflation has come in slightly below the June projections, all wage indicators are consistent with medium term target inflation and profit margins continue to come under pressure (as evidenced in the PMIs).
We therefore do not see convincing signs of any solid cyclical recovery – the stabilization in the growth data isn’t strong enough to prompt meaningful inflation concerns in our view. We therefore struggle with market pricing for three further 25bp hikes but admittedly conviction is lower on the precise path of the policy rate beyond 2.50% - which would be at the top end of neutral.
Reaction function and still “well positioned”: Lagarde is likely to retain optionality and avoid pre-committing to another move, repeating the ECB’s data-dependent and meeting-by-meeting approach. The key framework remains the same: the Governing Council will assess the inflation outlook, the risks around it, underlying inflation dynamics and the strength of transmission.
We do not expect a forceful push-back against market pricing, even though pricing for rates moving close to 3% in 2027 looks demanding if second-round effects remain contained. We still see value being built across the Bund curve as the market prices a policy path that increasingly assumes restrictive territory, while the evidence of broad-based domestic inflation pressure remains limited.'
