ECB Executive Board member Isabel Schnabel said policy action would still be required even if the Iran war ended immediately, citing damage to energy infrastructure. She indicated a June rate rise would be needed and said policymakers can no longer look through the inflation spike. Schnabel also pointed to growing signs the inflation shock is spreading beyond energy into other parts of the consumption basket.
She said the shock would weigh more heavily on growth, while incoming data points to upside risks to inflation alongside downside risks to growth. On financial conditions, she saw no concerning developments in bond yields. In markets, EUR/USD was down 0.12% on the day at 1.1630 at the time of writing.
ECB Rate Hike Path and Market Positioning
We see the European Central Bank’s path as set for a June rate hike, making it unwise to bet against it. The explicit language used means we should position for higher front-end interest rates. Shorting Euribor futures or buying put options on them for the summer contracts seems like the most direct trade.
The ECB’s hand is being forced by inflation that is clearly not temporary. Recent Eurostat data shows headline inflation is stubbornly high at 4.1%, with core inflation, which strips out energy, now at 3.8%. This confirms that price pressures are now widespread and embedded, leaving the bank with no option but to act.
Equity and Currency Outlook Amid Tightening
This combination of rising rates and a deteriorating economic outlook is a clear negative for European equities. We should be buying downside protection on indices like the Euro Stoxx 50. The latest S&P Global PMI composite for the bloc fell to 49.5, signalling a contraction in business activity for the first time in a year.
The weakness in the EUR/USD, even after these hawkish remarks, tells us the market is more worried about the growth forecast than the rate hike. This suggests that any rally in the euro will likely be sold into. We favour buying EUR/USD put options or establishing put spreads to position for further downside towards the 1.1500 level.
We believe the current policy stance echoes past ECB errors, particularly the rate hikes of 2008 and 2011, which occurred just before major economic downturns. This historical precedent reinforces our view that the central bank is tightening policy into a recessionary environment. The ECB’s assurance that it sees no concerning bond market developments is a green light for yields to rise further, making put options on German Bund futures an attractive hedge.
