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Nick Kounis, an analyst at ABN AMRO explains that the ECB’s rate hike expectations were scaled back following the June Governing Council meeting, when the central bank made its forward guidance more concrete, saying interest rates would remain on hold at least through the summer of next year.

Key Quotes:

“Over recent weeks they have re-traced somewhat. According to EONIA swaps and Euribor futures, we estimate that there is a significant probability of 10bp rate hike priced in for September of next year, with one fully priced in for October.”

“The consensus of economists (according to Bloomberg) is more hawkish, with a 20bp hike expected by September of next year. We expect the ECB to raise its deposit rate only in December of next year (by 10bp to -0.3), reflecting the likelihood that core inflation will undershoot the central bank’s forecasts. This implies another round of ECB re-pricing.”

“Given that no rate hikes are priced in any case for the coming year, we do not expect to see a big impact on the short end from any ECB repricing. Rather, we would expect to see lower German 5y and 10y yields over the next three months. That means we should see 2s5s and 2s10s flattening over the next few months, while 10s30s should steepen.”

“The various risks that continue to linger (such as a further escalation of Italian credit risk or protectionist measures) could also contribute to flattening pressure.”