Eurozone rate rise watching has been a pretty sleepy affair over the last six years, but signs of inflationary life in the continent have got investors eyeing the possibility of tighter monetary policy in the year ahead.
Markets are betting the European Central Bank could carry out its first rate hike since 2011 in the early part of next year. As of this week, the implied probability of hike to the eurozone’s deposit rate (now -0.4 per cent) and main refinancing rate (0 per cent) in April 2018 has jumped from 10 per cent to just under 40 per cent.
It comes as annual eurozone inflation climbed above the ECB’s target level for the first time since 2012 last month, hitting 2 per cent (the ECB aims for average inflation of just under 2 per cent).
Focus will now turn to ECB president Mario Draghi next week, when policymakers gather for their latest monetary policy meeting in Frankfurt.
Having vowed to hold interest rates at record lows and keep the stimulus taps running until policymakers see a sustained rise in inflation, Mr Draghi will be facing down hawks on his Governing Council who will be pushing the ECB to drop its commitment to the emergency stimulus measures which celebrate their two year anniversary this month. The ECB has vowed to buy €780bn of bonds this year.
But a reasonably robust economic recovery and faster than expected rise in prices should lead to a gradual shift towards a more hawkish ECB over the coming months, says Reinhard Cluse at UBS.
Mr Cluse thinks the central bank will begin to taper its QE measures at the start of next year.
“Given solid data and potential scarcity of assets available for QE, we now believe that tapering in 2018 will happen over 6-9 months rather than 12 months”, he said.
Any move towards a substantial scale back in bond purchases has also led investors to start betting on a gradual pace of rate rises from their record lows.
The ECB last raised rates in the midst of the eurozone’s debt crisis in early 2011 – a move that has since been seen as a major miscalculation which choked off demand and pushed back the continent’s recovery.