(Bloomberg) -- Traders are betting on an earlier start to European Central Bank interest-rate cuts next year and a deeper easing cycle, after a string of surprisingly low inflation readings in the region’s main economies.
A quarter-point decrease to the ECB’s deposit rate is now fully priced by April and an almost 50% chance is assigned for a cut as early as March, according to swaps tied to the central bank’s meeting dates. Just over a month ago, the expectation was for a first reduction in June.
Markets are also betting on four quarter-points of easing in 2024 — up from three last week — and are pricing a 70% chance of a fifth decrease, which would bring the deposit rate back to 2.75% from a record 4%.
The latest leg of the repricing comes after data Thursday showed inflation in France eased more than expected by all economists in a Bloomberg survey, with broad euro-area figures released later confirming the sharp deceleration.
Consumer prices in the common block rose 2.4% from a year ago in November, putting the central bank’s 2% target in sight.
Conviction that central banks will unwind their restrictive policy stance is building even as policymakers warn that borrowing costs will remain elevated for an extended period.
“The data back up the notion that policy no longer needs to be as tight as it is and so the pricing for cuts is basically accurate,” said Timothy Graf, head of EMEA macro strategy at State Street. “Despite ECB protestations to the contrary, inflation is cooling.”
European bonds gained after the data, extending a strong monthly rally that saw the yield on 10-year German notes fall 40 basis points, the most since July 2022. The euro fell as much as 0.5% to $1.0911, lagging gains in most of its Group-of-10 peers.
The ECB’s string of aggressive rate increases is expected to continue to take a toll on economic growth. Meanwhile, the effect of surging energy prices that followed Russia’s invasion of Ukraine has also dissipated, bringing consumer price growth back toward the ECB’s 2% target.
“We think it’s only a matter of time until the ECB formally acknowledges that it has overtightened policy,” said Simon Harvey, head of FX analysis at Monex Europe Ltd. He adds this will weigh on the euro, which may fall back below $1.09.
Yet some officials are pushing against that narrative, saying the battle to tame inflation is far from over. Core inflation — which strips out volatile items including food and fuel — is only expected to slow to 3.9% in the euro area, according to a Bloomberg survey.
“We find the market pricing on inflation returning to 2% from summer next year like a Goldilocks scenario, and see risks skewed to the upside,” said Piet Christiansen, chief strategist at Danske Bank.
This hasn’t stopped bonds from rallying, with a Bloomberg gauge of global sovereign and corporate debt headed for the biggest monthly gain since 2008, when the Fed cut rates to the zero bound and pledged to boost lending to the financial sector following the collapse of Lehman Brothers Holdings Inc.
Markets have also increased bets on Federal Reserve rate cuts, fully pricing a first move in May and foreseeing a total of 121 basis points of easing next year, up from 84 basis points on Friday.
Fed Governor Christopher Waller helped bolster rate-cut bets earlier this week, saying the current level of policy looks well positioned to slow the economy and bring down inflation. Some investors, including billionaire Bill Ackman, say the easing will start even earlier than traders anticipate.
--With assistance from Alice Gledhill and Naomi Tajitsu.
(Updates with euro-area inflation figures, investor comment starting in fourth paragraph, and prices throughout.)
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