Investors react to ECB’s hawkish line on inflation; analysts doubt

LONDON – Investors have placed strong bets in the futures market on an interest rate rise by March from the European Central Bank, whose hawkish rhetoric has even forced some to consider the risk of a hike before year-end. After tumbling yesterday, prices on Euribor futures, which reflect eurozone interest rate expectations, indicated the market assigned about a 75 percent probability to a quarter-point rise in borrowing costs by March. This is a sharp turn for a market that two weeks ago saw just a 30 percent chance of a hike by June and which initially hesitated to adopt a hawkish view of ECB President Jean-Claude Trichet’s «strong vigilance» posture regarding inflation. But overnight investors had second thoughts about his comments following Thursday’s widely expected decision to keep rates steady at 2.0 percent – as well as being also ruffled by inflation concerns voiced by Federal Reserve officials. Analysts are now on heightened alert for signals from eurozone indicators that could point to a hike, while surprisingly low figures for US job losses also gave global fixed-income prices a firm kick lower – including euro debt and Euribor futures. «You’ve got to pay close attention to the data for a change,» said an interest rate swaps trader in London. «You can’t rule out them (the ECB) doing something in December. I would assign a low probability to it but if the numbers fell a particular way it’s not impossible.» The December 2005 Euribor future now prices in about a 30 percent chance of a hike by year-end, whereas few if any would have bet on that before this week. By the end of next year, there should be two quarter-point rate rises in place, judging by Euribor futures prices. Investors have decided that the ECB sent a clear signal to the market that it will be looking for reasons to hike. Trichet underscored the ECB’s «strong vigilance» yesterday in an interview to Athens radio station Skai, saying the bank stood ready to raise rates if signs of second-round effects of high energy prices start to seep into the wider economy. But he also said that there was no need to raise rates yet as there was so far no evidence this was taking place. Analysts are aware that there have been plenty of false starts before, with moves in Euribor futures to discount risks of a hike being stopped by fresh signs of economic weakness. Despite the strong move lower in the futures market, some analysts say the ECB’s bark will prove worse than its bite and its benchmark rate may have stood at 2 percent for three years by this time in 2006. «The ECB will not walk the talk,» HVB said in a research note. «Our analysis clearly shows that the European Central Bank has so far not geared its interest rate decisions to inflation and definitely not to money supply data.» «Its benchmark so far was primarily the development of domestic demand. But the domestic economy in the eurozone will, after current signs of some life, fall back soon into its old lethargy. There is, thus, no scope for higher ECB interest rates.»