BOE & ECB Interest Rate Expectations Update

  


Central Bank Watch Overview:

  • The BOE and the ECB won’t meet again for six weeks. Nevertheless, speculation around what they may do next continues to drive markets.
  • Throttling back its QE program is just the beginning of the normalization process for the BOE, while rising inflation pressures may give pause to the ECB when thinking about another easing step.
  • Retail trader positioningsuggests that EUR/USD has a mixed bias while GBP/USD has a bullish bias.

Beginning to Throttle Back

In this edition of Central Bank Watch, we’ll cover the two major central banks in Europe: the Bank of England and the European Central Bank. Both central banks won’t meet again until late-June, giving ample space for speculation around their past, present, and future policy moves to dictate price action in EUR– and GBP-crosses. Throttling back its QE program is just the beginning of the normalization process for the BOE, while rising inflation pressures may give pause to the ECB when thinking about another easing step.

For more information on central banks, please visit the DailyFX Central Bank Release Calendar.

BOE Acting as Expected

The BOE set a target of purchasing £875 billion of UK government bonds through the end of 2021, and by altering the pace of QE over the next few months, the BOE will no longer reach its £875 billion target in early-October. Beyond that slight adjustment at their May meeting, which otherwise produced a new Quarterly Inflation Report, BOE policy is acting as markets expect, ‘steady as she goes,’ as it were.

Bank of England Interest Rate Expectations (May 11, 2021) (Table 1)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

It remains the case that “rates markets continue to take BOE policymakers at their word that interest aren’t going anywhere any time soon, nor will the main rate move into negative territory.” According to overnight index swaps, there is only a 3% chance of a 25-bps rate hike in 2021 and only a 16% chance through the end of 1Q’22.

IG Client Sentiment Index: GBP/USD Rate Forecast (May 11, 2021) (Chart 1)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

GBP/USD: Retail trader data shows 32.91% of traders are net-long with the ratio of traders short to long at 2.04 to 1. The number of traders net-long is 14.26% lower than yesterday and 32.40% lower from last week, while the number of traders net-short is 17.60% higher than yesterday and 44.12% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests GBP/USD prices may continue to rise.

Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger GBP/USD-bullish contrarian trading bias.

ECB Looking at Rising Inflation

The ECB has long-hinted at the possibility that its monetary easing facilities may not be fully utilized during the exit from the coronavirus pandemic, and that narrative may be invigorated this week around the April German inflation rate reading due out on Wednesday, May 12.

Although rising price pressures have been widely dismissed as transitory, global bond yields remain elevated, and it’s worth remembering that ECB Governing Council member Klaas Knot has previously said “what the market is actually doing is pricing that optimism” about a recovery in the second half of 2021. If higher inflation leads to higher yields, the ECB may interpret it as a sign that they don’t need to do more on the easing front.

EUROPEAN CENTRAL BANK INTEREST RATE EXPECTATIONS (May 11, 2021) (TABLE 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

According to Eurozone overnight index swaps, the ECB won’t be changing rates soon – one way or the other. In mid-January, there was a 54% chance of a 10-bps rate cut by December 2021; that probability now stands at a mere 2%. This is stark change in from where we were at the end of 2020, when rates markets were pricing in a 10-bps rate cut in July 2021; there is now a 4% chance of such an occurrence.

IG Client Sentiment Index: EUR/USD Rate Forecast (May 11, 2021) (Chart 2)

Central Bank Watch: BOE & ECB Interest Rate Expectations Update

EUR/USD: Retail trader data shows 34.01% of traders are net-long with the ratio of traders short to long at 1.94 to 1. The number of traders net-long is 5.55% higher than yesterday and 13.42% lower from last week, while the number of traders net-short is 1.94% lower than yesterday and 6.28% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.

Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.

— Written by Christopher Vecchio, CFA, Senior Currency Strategist

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