central bank Overview of the watch:
- The odds of a Bank of England rate hike are stagnant: the 2022 terminal rate has fallen from 2.176% to 2.099% over the past three weeks.
- Now that several European Central Bank policymakers have suggested a rate hike is possible in July, rate markets are pricing in a 100 basis point tightening through the end of 2022.
- retail trader positioning suggests EUR/USD and GBP/USD both have a bullish bias.
Divergence between central banks
In this edition of Central Bank Watch, we will discuss the two major European central banks: the Bank of England and the European Central Bank. There has been some divergence between the BOE and the ECB in recent weeks, with the former indicating that it will not accelerate its pace of rate hikes while the latter has made it clear that it will act sooner than expected. This narrowing of the expectation gap between the BOE and the ECB could soon trigger a reversal of the situation for the EUR/GBP, EUR/USD and GBP/USD rates.
For more information on central banks, please see the DailyFX central bank release schedule.
BOE Touring Ratings Stall
Bank of England policymakers are apparently at odds with the UK government, with the central bank warning of a significant negative impact on the cost of living in the UK while Prime Minister Boris Johnson brushes off such concerns. But as understood during the BOE’s rate decision in May, the Monetary Policy Committee seems just as concerned about the downside risks to growth as the upside risks to inflation, thus giving traders no reason to believe that the BOE will accelerate its rate pace. hikes in 2022.
Bank of England interest rate expectations (May 17, 2022) (Table 1)
UK overnight index swaps (OIS) discount a 133% chance of a 25bps rate hike in June (a 100% chance of a 25bps hike and a chance 33% of an increase of 50 basis points). Rates markets are still pricing in a 25 basis point rate hike at every meeting for the rest of 2022. And while that seems aggressive, this is a relatively slower pace than was expected at the end of April: the expected terminal rate for the BOE in 2022 now stands at 2.099%, down from 2.176% less than three weeks ago.
IG Customer Confidence Index: GBP/USD Rate Forecast (May 17, 2022) (Chart 1)
GBP/USD: Retail trader data shows 71.23% of traders are net long with a ratio of long to short traders of 2.48 to 1. The number of net long traders is 16.25% lower than yesterday and 19.35% lower than last week, while the number of net-short traders is 20.50% higher than yesterday and 32.18% higher than this week last.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net buyers suggests that GBP/USD prices may continue lower.
Still, traders are net less long than yesterday and compared to last week. Recent shifts in sentiment warn that the current GBP/USD price trend may soon reverse higher despite traders staying sharp.
ECB pressurized loop
How quickly things can change. When they met at the end of Aprilthe European Central Bank has suggested that the end of recovery efforts in 3Q’22 remains the most likely course of action, with rate hikes soon after. But as the Russian invasion of Ukraine continued, inflation took root, demanding an overhaul from various members of the Board of Governors.
Last week, ECB President Christine Lagarde said she would support a 10 basis point rate hike in July, followed by similar comments from Governing Council of the ECB mbrazier Mario Centeno today. Governing Council of the ECB member Klaas Knot went a step further by suggesting that a 50 basis point rate hike should be on the table.
This means that the gap between the ECB and rate hike expectations has closed, with the market winning. It now looks like the ECB will end asset purchases at its next meeting in June, paving the way for policy tightening in July. More importantly, as the ECB caved in to inflationary pressures, markets now expect a faster pace of rate hikes to occur over the course of 2022.
EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (May 17, 2022) (TABLE 2)
Eurozone OIS are now pricing in a 20 basis point rate hike in July (266% chance), a dramatic rise from the more subdued prices at the end of April. The €STR, which replaced the EONIA, is now priced for increases of 100 basis points until the end of 2022, compared to 60 basis points at the end of April. While the ECB still lags the other major central banks in terms of expected rate hikes, the expectation gap has narrowed significantly, which should help shield the euro from a deeper drop. (as long as the price of the rate hike remains high).
IG Customer Confidence Index: EUR/USD Rate Forecast (May 17, 2022) (Chart 2)
EUR/USD: Retail trader data shows that 68.78% of traders are net long with a ratio of long to short traders of 2.20 to 1. The number of net long traders is 10.78% lower than yesterday and 8.33% lower than last week, while the number of net-short traders is 20.02% higher than yesterday and 8.44% higher than this week last.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net buyers suggests that EUR/USD prices may continue to decline.
Still, traders are net less long than yesterday and compared to last week. Recent shifts in sentiment warn that the current EUR/USD price trend may soon reverse higher despite traders remaining sharp.
— Written by Christopher Vecchio, CFA, Senior Strategist