Traders are increasingly betting that the European Central Bank (ECB) will pause its plans to hike interest rates in September, as business activity in the eurozone continues to contract. This has led to a decrease in the likelihood of a 25 basis point move in September, with traders now pricing in a roughly 40% chance compared to over 50% earlier in the week. The contraction in German business activity, which is at its fastest pace in over three years, has deepened the downturn in the eurozone. Additionally, Britain’s business activity has also contracted sharply, raising recession risks in the country.
As a result, bond yields and interest rates in both the eurozone and Britain have tumbled. The euro has fallen to a more than two-month low against the dollar, and sterling has also dropped sharply. Investors have scaled back their expectations for where ECB and Bank of England rates will peak. The recent purchasing managers’ index suggests that lower rates may be on the horizon.
Germany’s 10-year bond yield has dropped to below 2.52%, and the Irish 10-year bond has also fallen sharply to 2.9%. In the US, business activity approached the stagnation point in August, with growth at its weakest since February. Demand for new business in the vast service sector has contracted. The sharp decrease in borrowing costs highlights the divergence between Europe’s weaker economy and the resilience of the US. Strong US data this month has led to expectations that interest rates will remain higher for longer, causing US treasury yields to reach their highest level in over a decade and lifting borrowing costs globally.
Citi economists have stated that the risk of the ECB having overtightened is significant, pointing to the purchasing managers’ survey as evidence that a September rate hike is less likely. JPMorgan now expects the ECB to pause in September and has postponed its expectation of a final quarter point hike to October. However, traders still anticipate two more quarter point rate hikes from the Bank of England, as it tackles higher British inflation compared to the eurozone. The upcoming eurozone inflation data will be key in determining investor expectations from the ECB.
Overall, the deepening economic pain in the eurozone and the contraction in business activity have led traders to believe that the ECB will pause its interest rate hikes in September. This is reflected in the decrease in the likelihood of a rate hike and the decrease in bond yields. The US, on the other hand, is experiencing resilience in its economy, leading to expectations of higher interest rates. The upcoming eurozone inflation data will provide further insight into the future actions of the ECB.