The return of oil prices to $100 ignites concerns about inflation, and traders increase their bets on interest rate hikes in Europe and the Bank of England

The Zhitong Finance App learned that as international energy prices continue to rise, increasing market concerns that inflation will continue to be high in the coming year, traders are drastically increasing their bets on further interest rate hikes by the European Central Bank (ECB) and the Bank of England (BOE). The interest rate swap market currently predicts that by the end of 2027, both central banks may increase interest rates by a total of about 90 basis points. However, some investors and Wall Street institutions believe that the market may have taken too much into account future interest rate hikes.

According to the latest interest rate swap pricing, the market currently expects the ECB to raise interest rates by a cumulative total of about 90 basis points by December 2027, the highest level since the current monetary tightening cycle. This means that the ECB is expected to implement at least three 25 basis point rate hikes during this period, while the market also takes into account the probability of a fourth rate hike of about 60%.

Expectations of the Bank of England's interest rate hike are also clearly heating up. The swap market anticipates that the Bank of England's cumulative interest rate hike will also be close to 90 basis points in the future. If this expectation is finally fulfilled, the UK benchmark interest rate will rise to the highest level since February 2025.

The central factor driving the market's rapid hawkish shift was the sharp rise in energy prices.

Europe and the UK are highly dependent on imported oil, particularly imported natural gas, so compared to energy producers such as the US, their economies are more sensitive to rising international energy prices. As energy supply risks rise due to the Iran war, international oil prices have once again broken through $100 per barrel. Investors are concerned that a new round of energy shocks may further push up inflation through channels such as transportation, electricity, production costs, and consumer prices.

Lauren van Biljon, senior portfolio manager at Allspring Global Investments, said that oil prices have returned to $100, while the economy and inflation in the UK and Europe are still highly correlated with energy prices.

In addition to the energy price shock, the Eurozone's economic performance is more resilient than previously anticipated, which is also an important reason why the market has greatly raised expectations of the ECB's interest rate hike. If the economy can afford higher interest rates, the ECB's policy space to control inflation will expand accordingly.

Currently, the market generally anticipates that the ECB will raise interest rates at the monetary policy meeting to be held on Thursday. ECB Governing Council member Joachim Nagel has also previously released this week's interest rate hike signals, but remains cautious about the policy path after that.

The sharp rise in expectations of interest rate hikes in the market also quickly spread to the European bond market. On Wednesday, European short-term treasury bond yields generally rose. Among them, German 2-year treasury bond yields, which are most sensitive to changes in monetary policy, once rose to 3.08%, the highest level since June 2024.

However, as the market begins to bet that the ECB and the Bank of England may carry out multiple rounds of interest rate hikes in the future, some investors believe that current pricing has become too aggressive.

Although ECB officials have shown a high degree of openness to the recent further tightening of monetary policy, they are still relatively cautious about raising interest rates several times in a row. While hinting at a possible rate hike on Thursday, Nagel made no clear commitment to continued austerity in the future.

On the Bank of England side, Governor Andrew Bailey also tried to downplay the possibility of another interest rate hike in the near future.

Emma Moriarty, portfolio manager at CG Asset Management, believes that considering that the UK economy is still weak, it is unlikely that the impact of inflation is so severe that it will require the Bank of England to implement as many as four interest rate hikes to control it.

Van Biljon also believes that the current rapid rise in expectations of the Bank of England's interest rate hike “does not seem reasonable.” Market expert Evelyne Gomez-Liechtenstein said that currently investors may be “mistakenly inclined to bet too much on interest rate hikes” with the ECB and the Bank of England.

Bank of America strategists also advised investors to be wary of hawkish expectations currently included in the ECB's short-term interest rate market. The bank believes that there is currently no sufficient evidence that the rise in energy prices has evolved into broader and more lasting inflationary pressure, and that increasing economic headwinds in the Eurozone in the future will also limit the extent to which the ECB can raise interest rates.