Bank of England and ECB highlight market curve may overstate likely pace of future rate hikes
Expectations that central banks will be forced into a series of rate hikes have hardened over the past week. The deteriorating prospects for the conflict in the Middle East being resolved, pushing Brent oil prices above $100pb, has been the clear catalyst, bolstered by rate hikes and the hawkish messages emanating from the Bank of England, ECB and Federal Reserve September policy meetings. Hence, 5-year swap rates are now back close to the peak levels seen in 2022/23 following the outbreak of war in Ukraine. These elevated swap rates also reflect the pessimistic view embedded in OIS curves that central banks will need to keep rates in restrictive territory out to the end of the decade.
However, both the Bank of England and ECB have stressed that the market curve not only captures investors’ view of the most likely path for policy rates, but also compensation for risk and uncertainty. Last week, ECB Chief Economist Philip Lane unveiled estimates that c30-40bps of the tightening to 3.5% embodied in the OIS curve reflected such ‘term premia’. This view is similar to previous estimates from the Bank of England (c50bps) for the Sterling OIS curve. The message here is that investors’ view of the most likely path for ECB policy rates may be two further 25bp hikes to 3%, but with market rates being pushed above 3% because the risks to oil prices and CPI inflation are skewed to the upside.
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