Traders ramp up bets on 75 basis-point ECB Sept hike, bond yields jump

By Yoruk Bahceli

(Reuters) -Euro zone money markets moved on Monday to price in a two-thirds chance of a large 75 basis-point European Central Bank rate hike in September after policymakers made the case over the weekend for a large move to tame inflation four times above their target.

Particularly in focus was ECB board member Isabel Schnabel, who argued that the risk is rising that long-term inflation expectations “de-anchor” from the bank’s 2% target and surveys suggest inflation is denting public trust in central banks.

Others said frontloading hikes would be reasonable and that the neutral rate, estimated around 1.5%, should be reached before year-end or first quarter 2023.

Traders on Monday priced in as much as 67 basis points of rate hikes at the bank’s Sept. 8 policy meeting, meaning they fully priced in a 50 basis-point move and a 67% chance of a 75 basis-point move, Refinitiv data showed.

That compares to a 24% chance of the larger move they priced on Friday, before a Reuters report that some policymakers wanted to discuss the bigger move raised the odds to 48%.

“The most important signal (from Jackson Hole) was from Schnabel who talked about the risk of inflation expectations moving above target, that the central bank would have to hike rates more violently, and that is something new,” said Jan von Gerich, chief analyst at Nordea.

As rate hike bets rose, Germany’s two-year bond yield, sensitive to interest rate expectations, rose as much as 19 basis points (bps) on the day to 1.162%, the highest since June 17.

Its 10-year yield, the benchmark for the euro area, rose as much as 15 bps on the day to 1.548%, its highest in two months.

“The ECB clearly looks with determination to frontload the hikes and this will linger on ahead of the September meeting,” said Piet Christiansen, chief analyst at Danske Bank in Copenhagen, now expecting a 75 bps hike.

ECB chief economist Philip Lane added to the comments on Monday, saying the bank should raise interest rates at a “steady pace” and that appropriate increments will be larger the wider the bank is form peak rates and the more skewed the risks are to its inflation target.

Bond yields eased from the day’s highs as gas prices dropped sharply after Germany’s economy minister said he expects prices to fall as Germany is set to hit its 85% Oct. 1 storage target in early September. Germany’s 10-year yield was up 9 bps by 1350 GMT.

Ten-year yields in Italy, a key ECB stimulus beneficiary, jumped as much as 17 bps to 3.873%, the highest since mid-June, pushing the closely-watched spread to German peers to 236 bps, the highest in a month.

Rohan Khanna, strategist at UBS, said the more front-loaded rate hikes, the more likely the ECB will have to consider activating its Transmission Protection Instrument, under which it will buy bonds from countries whose borrowing costs relative to Germany are rising through no fault of their own.

“The harder the ECB pushes on the rate-hike pedal, the faster we are likely to get to 300 bps on this spread,” he said.

(Reporting by Yoruk Bahceli, additional reporting by Dhara Ranasinghe; Editing by Dhara Ranasinghe, Emelia Sithole-Matarise and Angus MacSwan)