ECB Rate Hike Expectations Dim as Contagion Risks Rise

MUFG’s Lee Hardman highlights how the recent tightening in Eurozone financial conditions is reshaping expectations for European Central Bank (ECB) rate hikes. The market has adjusted its forecasts, now aligning more closely with MUFG’s prediction of two additional rate increases. However, Hardman warns that if fragmentation risks, where financial stress spreads across different Eurozone economies, worsen, even this forecast may be too aggressive.

The current financial tightening has led investors to reduce their bets on further ECB rate hikes, partly due to the shock of rising energy prices. There is also growing speculation that the ECB might need to ease contagion risks by slowing its quantitative tightening (QT) or even activating its Transmission Protection Instrument (TPI) for the first time.

Using the TPI would be a significant step, as it would imply the ECB is helping governments finance their deficits. Hardman notes that the ECB would only resort to this measure if the bond purchases are temporary and if governments take steps to tighten fiscal policy to restore investor confidence.