- For the first time in over three years, the European Central Bank (ECB) has raised borrowing costs to address inflation pressures triggered by the Iran conflict. Although eurozone government bond yields fell on Thursday due to signs of easing geopolitical tensions, currency market traders still maintain expectations of further rate hikes within the year.
- According to the latest swap market pricing, traders have fully priced in a future 25 basis point rate hike and estimate a 60% probability of another 25 basis point increase. They are betting on a total of about 40 basis points of further hikes within the year, with no policy turning point in sight.
- Germany's 2-year government bond yield (DE2YT:RR) and 10-year government bond yield (DE10YT:RR) both fell by 4 basis points on Thursday, to 2.67% and 3.03% respectively, as news of a face-to-face meeting between the UAE and Iran eased immediate market risk aversion.
Central Bank's Hawkish Stance and Economic Forecast Revisions
In its latest policy meeting, the European Central Bank adjusted its macroeconomic forecasts, significantly raising future inflation expectations while slightly lowering economic growth forecasts. This move makes it the first major central bank to raise rates since the outbreak of geopolitical conflict. ECB President Christine Lagarde stated that the current rate hike decision remains reasonable under multiple scenarios where the conflict's impact is lighter or heavier than the baseline scenario. Analysts generally believe this statement highlights policymakers' high vigilance against potential inflation stickiness, reinforcing the market's overall judgment of the central bank's hawkish monetary policy bias.
Continuation of Market Tightening Expectations and Rate Hike Pricing
Currency market traders, after assessing the policy statement, continue to maintain marginal bets on further rate hikes within the year. The latest pricing data shows that the market expects the ECB to further raise rates by about 40 basis points this year. This data indicates that the market has fully priced in a 25 basis point rate hike and believes there is a 60% probability of another hike on top of that. Compared to the level before the rate decision announcement, traders' tightening expectations have only slightly decreased, reflecting a strong consensus on the continuity of subsequent monetary tightening policies.
Geopolitical Easing Triggers Yield Pullback
In secondary market trading, eurozone sovereign bond yields showed slight pressure on Thursday. Germany's 2-year government bond yield recently fell by 4 basis points to 2.67%, and the benchmark 10-year government bond yield also fell by 4 basis points to 3.03%. The core factor driving yields to rise and then fall after the decision was the news of a face-to-face meeting between UAE and Iran representatives aimed at easing tensions. The immediate unwinding of geopolitical risk premiums prompted some safe-haven funds to flow out, pushing prices up and thus lowering overall government bond yields.
Institutional Views and Future Inflation Path Variability
Demi Angelaki, a portfolio manager at Aviva Investors, pointed out that the latest forecast path indicates that the risk of rising inflation is significantly higher than the risk of economic slowdown. If inflation data continues to show stubborn characteristics, it is highly likely that the ECB will continue to follow up with rate hikes when updating economic forecasts in September. However, the policy path still has conditional variables, and the ECB also mentioned that if energy prices fall faster than expected, in a moderate scenario, the overall eurozone inflation rate could fall below the 2% target level by next spring. If core inflation does not cool as expected, the market's pricing of the duration of restrictive rates may face reassessment.
Cross-Cycle Policy Trade-Offs and Macroeconomic Uncertainty
In the medium to long term, the ECB faces dual pressures of price stability and economic growth trade-offs. The dynamic evolution of geopolitical situations directly affects the stability of commodity and energy supply chains, adding more external noise to the traditional monetary policy transmission mechanism. If subsequent core inflation indicators show stronger resilience than expected, it is not ruled out that policy rates may remain in the restrictive range for a longer period. Market participants need to closely monitor the marginal changes in monthly inflation data to adjust their expectation models for the eurozone's terminal interest rate.
