Chart of the Week: Will the ECB lead the rate cuts?

Markets worldwide are positioning themselves for rate cuts in the new year, pushing yields down and increasing demand for risky assets. Nowhere has that shift been more dramatic than in the euro area. The European Central Bank (ECB)’s refinancing rate currently stands at 4.5%, having last been raised in September, following the Fed’s latest hike with a three-month lag. The overnight index swaps (OIS) market now suggests that this rate will be cut by 50 basis points in the first three months of 2024, with further cuts of roughly the same size by September 2024. Notably, the forward rate for the nine-month-ahead OIS has been slashed by 40 basis points in two weeks, reflecting a strong conviction that ECB cuts will be front-loaded next year. And while the mixed jobs report from the US suggests that the expectation of cuts as early as March 2024 may be premature, the overall sentiment is that cuts are coming, and they may be led by the ECB. The reason is that Europe differs from the rest by the intensity of the energy price crisis it suffered last year due to the Russo-Ukrainian conflict. Prices have come down since then, with most of the improvement occurring in the countries where gas prices rose the most a year ago — like Germany. That guides the markets to believe that inflation will be down to target in one year; so much so, indeed, that only a week ago the market started believing that euro area inflation would be below US inflation in a year’s time.

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The views expressed in this article are the views of the author, not necessarily those of LSEG.

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