The headquarters of the European Central Bank in Frankfurt. Eurozone money markets have in the past two months brought forward interest rate hike expectations by three years to 2018 – a tightening in monetary conditions the ECB could do without.

Reuters
London


Eurozone money markets have in the past two months brought forward interest rate hike expectations by three years to 2018 – a tightening in monetary conditions the European Central Bank (ECB) could do without.
This move in the forward curve of Eonia overnight interest rates, which affects borrowing rates for companies and consumers, reflects a shift from an outlook of deflation in the 19-country bloc towards one of inflation.
While a rise in inflation expectations is one goal of the ECB’s €1tn bond-buying programme launched in March, further moves to price in earlier interest rate hikes could derail the eurozone’s fragile recovery.
ECB President Mario Draghi made clear his concern last week, telling the European Parliament he was closely monitoring financial conditions for any “unwarranted tightening”.
Money markets are thus becoming the place to look for any hints that the ECB might alter the terms of its stimulus programme.
With spot Eonia rates at about -0.11%. The zero level on the forward curve is widely considered the point at which the market is pricing in a rate hike, as it is widely assumed that any such move would be equal to the ECB’s last rate cut, which was by 10 basis points.
Three-year forward Eonia rates are now zero. In mid-April, when interest rates hit record lows across the eurozone, six-year rates traded at zero.
“We have flirted with deflation and we now seem to have pulled ourselves up from that particular brink,” Credit Agricole global head of fixed income strategy, said David Keeble, said.
“The market priced in a Japanese-type scenario which probably was inappropriate. Now three years seems about right.”
The speed with which the ECB hikes rates after it exits its ultra-easy monetary policy stance is also seen accelerating. Ten-year Eonia rates have risen to nearly 0.80% from 0.15% two months ago.
Most analysts do not consider the current level of interest rates as too high for the ECB’s comfort. ING senior rate strategist Martin van Vliet said that if expectations for a hike were to be brought forward to early 2017, less than six months after the quantitative easing (QE) programme is due to end in September 2016, the ECB may begin to worry.
“I would expect if they think this is unwarranted tightening they would just step up their rhetoric and say ‘look guys, this might prompt us to make our QE programme even longer if this continues’,” van Vliet said.
Keeble said that in such a scenario, which is not the base case for market participants, the ECB could even top up the purchases by another 10bn euros a month to 70bn.
Gianluca Ziglio, Sunrise Brokers executive director of fixed income research, said money market rates could rise further and price in ECB hikes sooner.
He points to ECB inflation forecasts of 1.5% in 2016 and 1.8% in 2017, which is around the ECB’s target of just below 2%. If the ECB feels confident those levels will be reached, then it might start thinking about hiking rates soon after its QE programme ends.
“What you know now is when the easing is over. But it’s not going to take a year and a half before the ECB starts raising rates,” Ziglio said.