Bond traders punishing ECB focus on supporting growth

Bond traders are punishing the European Central Bank’s focus on supporting growth in the face of record-high inflation.

German 30-year yields surged to a three-year high, with markets left unsatisfied by the central bank renewing a pledge to conclude bond-buying in the third quarter – a step toward normalising policy amid growing risks from surging prices.

Meanwhile, short-end rates – the most sensitive to monetary policy – fell, widening the gap between the pair by the most since the coronavirus pandemic first struck two years ago.

Traders trimmed bets on a July rate hike, seeing just a 50 per cent probability of such a scenario, after president Christine Lagarde emphasised the threat to economic growth from Russia’s invasion of Ukraine.

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They hardly budged even after reports that consensus is building among governing council members for a quarter-point rate increase in the third quarter.

The ECB last raised borrowing costs in 2011, when inflation quickened to the fastest in two and a half years in the midst of a debt crisis that forced the euro area’s periphery nations to seek bailouts from their peers.

The move backfired, forcing the central bank to reverse course by year-end in a futile attempt to avert a recession.

“With the lessons in mind from 2011, Lagarde came across as being attentive not to make a similar mistake of hiking into a significant slowdown rather than tightening on an elevated inflation outlook,” said Piet Christiansen, chief strategist at Danske Bank.

Money markets erased bets on a 25-basis-point rate cut within four years. That contrasts sharply with wagers on a quarter-point of easing in two years from the Federal Reserve, following 300 basis points of hikes priced in.

It’s a sign that traders see the ECB managing a softer economic landing from a tightening cycle than its US counterpart.

“As regards the Fed, which Lagarde also said the US economy is fundamentally different from the euro area, they are on a mission to get economic activity lower, which signals aggressive tightening,” said Christiansen. – Bloomberg