(Bloomberg) -- Traders are ramping up bets on monetary easing from the European Central Bank next year, raising the stakes for President Christine Lagarde as she prepares for a policy meeting next week.
Markets fully priced six quarter-point rate cuts by the European Central Bank in 2024 earlier on Wednesday, a move that would take the key rate to 2.5%. Although bets were pared slightly later in the day, Deutsche Bank helped stoke the dovish sentiment by revising its outlook to also forecast 150 basis points of cuts.
While policymakers are still warning of the threat posed by inflation, a slew of dovish comments in recent days has suggested hikes above 4% will likely not be needed due to the decline in inflation. Markets are now pricing in an almost 90% chance of the easing cycle starting in the first quarter of next year, a scenario that was barely contemplated just three weeks ago.
If traders are right, the ECB will be the first among major central banks to cut rates next year, and will deliver the most aggressive easing cycle. In the US, where headline inflation has slowed to an annual pace of 3.2%, the Federal Reserve is expected to deliver its first move in May and lower rates by 125 basis points in total.
“Given the latest inflation data and the tone of official commentary, we fear we were too timid,” economists at Deutsche Bank led by Mark Wall said Wednesday in a report to clients. “The risk is now earlier and larger cuts, and an ECB more capable of decoupling from the Fed.”
Deutsche now sees the first rate cutcoming in April rather than June, with a “significant risk of a cut” in March and 150 basis points of easing in total through the end of the year.
The view that the ECB and other major central banks will have to ease monetary conditions to support their economies next year has boosted bonds. The yield on 10-year German bonds has dropped about 80 basis points to 2.23% over the past two months, the lowest level since May.
That’s led some in the market to start cautioning against excessive optimism. Strategists at BlackRock Inc. say they “see the risk of these hopes being disappointed” and Goldman Sachs Group Inc.’s strategists are recommending options bets to counter excessive rates pricing.
Stephanie Niven, portfolio manager at Ninety One, says euro area rate cuts are more likely to emerge at the end of next year given central bankers have been guiding toward a higher-for-longer scenario. Lagarde has warned that the medium-term outlook for inflation remains highly uncertain.
“It’s interesting looking at all the narrative around Europe, the flip-flopping that we’ve seen just in the last three weeks,” Niven said in a Bloomberg TV interview. “Europe has both cyclical and structural challenges, and that’s what causing a lot of that oscillation and volatility about what markets are really expecting the ECB to do.”
Euro-area consumer prices grew less than expected in November, by 2.4% year-on-year from 5.3% in August. That’s closer to the ECB’s 2% target than at any point since mid-2021.
At the same, economic data shows further signs of weakness. German factory orders unexpectedly fell in October, highlighting how manufacturing in Europe’s largest economy remains stuck in a rut.
“The European economy has been steadily deteriorating over the past 12 months as financial conditions have tightened,” said Gareth Isaac, head of multi sector portfolio management at Invesco. He expects labor markets to soften next year, “providing the ECB with the cover to begin cutting rates sharply as inflation falls back to target.”
--With assistance from James Hirai.
(Updates with Deutsche forecast in second paragraph, fresh pricing throughout.)
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