BoE and ECB monetary policy changes drive interest rates higher
Managing Partner, Board Member
Head of Europe
Real Estate | London
2022 has started with a bang when it comes to movements in capital and money markets. The end of COVID-19, and associated policy responses, is giving rise to an economic environment which is causing central banks to rapidly reposition their stance on monetary policy. The Bank of England (BoE) and the European Central Bank (ECB) each made key announcements this week on monetary policy. Both contained surprises which led to large moves in the interest rate markets.
BoE policy announcement
The BoE had already signalled an increase in base rate from 0.25% to 0.5%, and while this is the first back-to-back rise in rates since 2004, it was fully priced into the market. They also, again as expected, announced that they would not reinvest the proceeds of maturing government bonds as they start their process of quantitative tightening (QT). The two surprises from the meeting were that four of the nine committee members voted for a more aggressive 50 bps hike and that the BoE is now expecting inflation to remain materially above the 2% target this year, peaking at 7.25% in April.
It was this messaging, and the commentary from the minutes, which pushed interest rates up — both government gilt yields (10-year benchmark increased 11 bps to 1.36%) and the swap market with the three-year swap rate now at 1.48%. The chart below shows how much this benchmark borrowing rate has moved since the end of September last year when inflation fears started grabbing headlines. Markets are now expecting base rate to be at 1.5% by the middle of this year. This will be the fastest tightening of monetary policy since the BoE gained independence in 1997. The second chart below shows the forward curve (market’s expectations of future interest rates) and the increase over the past few weeks.
ECB policy announcement
In the EU, swap rates started increasing even before the ECB formally announced their interest rate decision. While rate rises from the ECB are expecting to be further away, the market sentiment now is that these might happen sooner.
The ECB maintained its stance of no change in rates, but there was a substantial change in guidance and language used. ECB president Christine Lagarde stated at their December meeting that a 2022 rate hike was “very unlikely”. This week, Lagarde did not repeat that statement and instead highlighted that given the inflation backdrop the “situation had changed”. The ECB 10 March meeting will be critical as the Council will have a fuller set of economic data on which to base their decisions. On QT, the ECB has continued with the plan to end asset purchases and are comfortable doing this before they start raising interest rates. This QT signalling is increasing market interest rates anyway, and doing the tightening work for the ECB. Before this most recent meeting, it was not expected that EU rates would move above 0% until well into 2023; but as of now, the market expects this to be by the end of this year. The charts below show the three- and five-year swap rates for EURIBOR and the forward curves.
Many of our clients hedge interest rate risk using caps as their product of choice. It is worthwhile noting that the underlying interest rate (as we have discussed above) as well as the volatility of the underlying rate impacts the premium cost of these caps. This week we have seen large movements in both, so if you have indications from your banking counterparties on premiums/rates be aware of how much they will have moved up. Please connect with your Chatham relationship contact if you would like to discuss further.
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Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.
Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.22-0036
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