The ECB holds firm while the BoE wavers
Hedging and Capital Markets
Real Estate | London
On 15 December, the European Central Bank (ECB) voted for a further 0.5% interest rate increase as the central bank continues its policy of monetary tightening in the face of high inflation. The bank slightly slowed the pace of increases (from 0.75% previously) as signs of a softening inflation picture have started to emerge. The narrative in the press conference, however, was more hawkish than expected.
By contrast, the Bank of England (BoE) was split in its approach by voting 6-2-1 for a further 0.5% hike. Signs of division emerged within the Monetary Policy Committee (MPC) with two members voting for maintaining the current levels, and one member voting for a 0.75% hike. The U.K.’s weak economic performance and the spectre of stagflation overshadowed the need for continued aggressive hiking.
- The BoE raised the base rate by 0.5% to 3.5%
- The ECB raised the Deposit Facility Rate by 0.5% to 2.00%
- As of 12:30 GMT, the 10-year GBP swap traded at 3.34%, 5-year at 3.69%, 3-year at 3.97%
- As of 13:45 GMT, the 10-year EUR swap traded at 2.63% 5-year at 2.65%, 3-year at 2.78%
- The vote was split 6-2-1 reflecting division within the MPC
- The tone from the ECB suggested rates would continue to rise “significantly”
The ECB is sticking true to the course laid out by Christine Lagarde in recent press briefings where she stressed that rates would need to continue to rise, even in the face of a sputtering economy, to bring inflation under control. Lagarde addressed EU legislators and stated that uncertainty, a tighter monetary environment, and weakening global demand are weighing on growth, which is “expected to continue weakening for the remainder of this year and the beginning of next.”
The rate hikes are taking their toll across the EU with the news this week that even national banks are feeling the strain. The National Bank of Belgium (NBB), Belgium’s central bank, had trading in its shares suspended on Monday as prices plunged to their lowest levels since 1996. The impetus for this sell off came on their announcement that they expect €9 billion in losses in 2023–2026, as a result of ECB interest rate hikes, completely wiping out all of the NBB’s provisions and equity,sending ripples of shock through the broader capital markets.
This underscores the delicate balancing act being undertaken by Lagarde and the ECB as risks to the financial stability of the Eurozone increase. The Russia-Ukraine war, soaring prices, and low growth lead to concerns that the stresses on the financial markets could create a single point of failure, which then cascades into a broader contagion, potentially putting key economic infrastructure at risk. The current macro environment represents some of the most rigorous stress testing of the post 2008 regulation and its impact upon financial stability across the bloc.
The language used in the press release and the following conference struck a more hawkish tone than markets anticipated, with the ECB using strong language in the face of an upward revision to the inflation outlook. Lagarde said, “rates would still need to rise significantly at steady rates to reach levels that are sufficiently restrictive to return inflation to the 2% target.”
EUR swap rates rose sharply at the short end of the curve before settling back following the announcement. The 3-year EUR swap rate was up 6 bps to 2.78%, the 5-year EUR swap rate was up 5 bps 2.65%, and the 10-year EUR swap rate was up 3 bps to 2.63%. The expectation is for rates to increase by a further 50 bps at the next meeting in February, and the peak of projected rates increased 6 bps from 2.84% to 2.90% in the second half of 2023.
The BoE voted 6-2-1 to raise the U.K. base rate by 0.50% to 3.50%, with dissenters split, voting for hikes of 0.75% and keeping rates as they were. The pattern of votes represents some of the deepest divisions in the MPC in recent times with an ideological battle between the hawks and the doves on the best way to handle the current challenging economic circumstances.
Central Bank staff are broadly anticipating a recession in early 2023 with a projected 0.1% reduction in GDP in Q1. The risk of stagflation, the process by which the economy suffers but inflation remains high, seems to be at the forefront of the debate with concerns about longstanding damage to the U.K.’s economy and workforce highlighted in the letter from Andrew Bailey to the chancellor where he highlights that, “there are considerable uncertainties around the outlook. The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary.”
The Bank outlook on inflation is marked in the commentary that YoY CPI has peaked following the fall from 11.1% in October to 10.7% in November. However, this view is moderated slightly with the caveats that the U.K. labour market remains strong, despite a small uptick in unemployment figures, and an upside risk on wages. With private sector pay rising above expectations, and the U.K. battling some of the most aggressive strike action in decades from a wide range of public sector workers over the cost of living, the Bank’s Agents expect further upward pressure on pay growth next year.
Markets are pricing in 1.6 hikes at the next MPC meeting in February for a total projected increase of 0.41%. This is 7 bps lower than pre-meeting projections of 0.48% and the peak of projected rises came down by 20 bps when compared to yesterday’s numbers.
GBP swap rates fell at the short end of the curve following the announcement. The 3-year GBP swap rate was down 7 bps to 3.97%, the 5-year GBP swap rate was down 6 bps to 3.69%, and the response in the 10-year GBP swap rate was more muted at 3.34% from 3.38%.
Chatham’s expert advisors and technology are core to helping our clients hedge their interest rate risk. To follow the developments of the market’s expectations of the forward curve, visit Chatham Rates or subscribe to our newsletter below.
Subscribe to receive analysis and insights regarding the Bank of England/European Central Bank policy updates
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.22-0092
Our featured insights
BoE and ECB keep rates on hold, but rate cuts grow more likely
The Bank of England (BoE) voted to keep rates on hold as expected at 5.25%, though one member of the Monetary Policy Committee (MPC) voted for a rate cut, the first vote since the Bank cut rates to a record low in March 2020. Two members voted to hike rates, but a subtle change in the...
Major central banks hold rates steady; markets price in rapid cuts
The Bank of England (BoE) held rates for a third consecutive meeting at 5.25% with a vote of 6–3. The bank rate remains at the highest level since the financial crisis, amidst the backdrop of inflation more than double the Bank’s target and a stagnating economy. The latest data shows the U.K....
BoE holds rates steady again while ECB pauses record run of hikes
The Bank of England (BoE) kept rates on hold at 5.25% for a second consecutive meeting today, as it attempts to balance a weakening economy with inflation that is still measuring three times its target. The Bank's updated forecasts show medium-term inflation slightly higher than in August's...
Jackie Bowie discusses the Bank of England's interest rate decision on Sky News
Business Live host Ian King interviews Jackie Bowie about the Bank of England's November interest rate decision. Will the decision follow the consensus of pausing the interest rate hike, or will the Bank continue rising?
Jackie Bowie reviews the 10-year Treasury and interest rates on Bloomberg Daybreak Europe
Bloomberg Daybreak Europe interviews Jackie Bowie about the Bank of England's November interest rate decision. With the U.S. refunding announcement in focus alongside a headwind of geopolitical risk, there have been negative views impacting sentiment as more people are paying attention.
Market update as regulators take control of troubled banks
Since Friday, March 10, we’ve observed the distress of two banks, Silicon Valley Bank and Signature Bank, which have both been placed into FDIC receivership. The FDIC has taken the step of guaranteeing the deposits of both banks above the legislated $250K per account limit, and the Federal Reserve has demonstrated further commitment to ensuring bank liquidity by establishing the Bank Term Funding Program.
The first 75 bps hike from the Bank of England in 33-years in a split vote
On 3 November, the Bank of England (BoE) voted seven-to-two to raise the U.K. base rate by 0.75% to 3.00%, the two dissenters voting instead for hikes of 0.25% and 0.50%. The BoE Governor, Andrew Bailey, voted for the 0.75% hike while pointing to a slowdown in the pace of future hikes. This move...
Inflation persists despite historically fast hikes
On Wednesday, November 2, the Federal Open Market Committee (FOMC) voted unanimously to raise the federal funds target range by 75 basis points to 3.75–4.00%. This rate hike is guided by their long-term dual mandate of price stability and simultaneously ensuring maximum employment. The Fed is...