Major investment banks are bringing forward their expectations of a euro zone interest rate hike as they increasingly believe a tough-sounding European Central Bank could finally pull the trigger by the year-end.
Bank of America and UBS say they now expect the ECB to tighten monetary policy in December after leaving its key rate at 2.0 percent since June 2003, although Goldman Sachs feels markets may be going too far for this year at least. The ECB, which meets on Thursday, has persistently rung alarm bells on inflation dangers in the past few weeks as it tries to insulate the euro zone against rising oil-induced price pressures and potential wage hike demands.
That has woken up the investment banks, which had so far taken a much calmer approach to rates than money markets which have aggressively factored in a rate hike.
The interest rate futures market now sees more than a 60 percent chance of a rate hike in December against a 40 percent probability some 10 days ago.
The revival of domestic demand in Germany, strong business confidence and strong money supply growth in the euro zone have convinced many banks that the ECB could finally turn its words into action.
"The ECB cannot continue to massage inflationary expectations for many more months without actually delivering," Bank of America said in a research note.
"We now believe there is a slightly better-than-even chance to see a 25 bp hike in December, with 25 bps per quarter thereafter. On Thursday, (ECB President Jean-Claude) Trichet may drop a clear hint," it added.
UBS also now projects a 25 basis point rate hike in December and another in first quarter of 2006.
Earlier this month, Deutsche Bank was among the first to say the ECB may raise rates within the next few months and saw a slightly more than 50 percent chance of a move in December.
These changes are bringing banks' expectations in line with positions taken by investors in the money market.
Euro zone government debt has been hammered this month as investors bet on a rate hike by December, and two quarter percentage point hikes by next June. This is in sharp contrast to market expectations of a rate cut by the ECB as recently as July.
Merrill Lynch said in a report that the recent shift in ECB talk, economic data and market moves have forced it to rethink its monetary policy forecast for the euro zone.
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