Euro Slides as Cooling Inflation Dampens Rate Hike Bets 

European Bond Rally as Rate Hike Expectations Cool

European government bond yields have witnessed a surge, while the euro and Nordic currencies like the Swedish krona have slumped. This follows the release of cooler-than-expected inflation data and weak economic indicators from China. These developments suggest a potential pause in the European Central Bank’s (ECB) rate hike cycle.

Slower Inflation Pushes Back ECB Rate Hikes

Bond yields, particularly Germany’s 10-year yield, have fallen significantly. Additionally, inflation readings in major economies like France and Germany came in lower than anticipated. This has prompted money markets to adjust their forecasts, reducing bets on further ECB rate hikes.

Disinflationary Concerns Amidst Global Slowdown

The slowdown in European industry coupled with China’s struggles to emerge from its strict Covid-Zero policies have heightened concerns about global disinflation, meaning inflation is falling below desired levels. This economic fragility pushes the world economy closer to recessionary territory.

Euro and Nordic Currencies Under Pressure

The negative economic outlook has impacted the euro and the Swedish krona. The euro reached a multi-month low against the US dollar, while the krona is on track for its worst monthly performance in over a decade.

Traders Revise Rate Hike Expectations

Financial markets no longer anticipate the full 50 basis point rate increase previously priced in for the ECB. Instead, traders predict the key rate to peak slightly below 3.75% by September, compared to the current deposit rate of 3.25%. This shift reflects the dovish turn in monetary policy expectations.

Bond Yields to See Rangebound Trading

European government bonds are likely to trade within a range established over the past month, with 10-year bond yields predicted to fluctuate between 2.20% and 2.50%.

Riskier Currencies Impacted

The disinflationary trend has also weighed on riskier currencies like the Swedish krona and Norwegian krone. This suggests that central banks in Sweden and Norway may halt their rate hikes sooner than the ECB, making their currencies less attractive for carry trade strategies.

Potential for Further Euro Weakness

Financial analysts predict a single rate hike in September, barring any unforeseen rise in core inflation. While the market anticipates further ECB tightening, the moderating inflation data and the threat of eurozone stagnation could lead to further weakening of the euro against the dollar in the coming weeks.