Investors trimmed expectations of how aggressively the ECB will raise interest rates as a result of spreading stress in the sovereign bond market on Monday, but analysts said a rate hike in July remained priced in. The interest rate expectations implied by Euribor futures fell across the 2011/12 curve, breaking out of their recent range as government bond market worries threatened to infect the eurozone's larger peripheral states.
Italy's creditworthiness was in the spotlight after Standard and Poor's lowered its rating outlook to negative, causing a fresh rise in bond yields across the region's lower-rated states and boosting demand for safe-haven German debt. "Surely market participants would now question whether the ECB can hold up to its hawkish talk and go on with the hiking cycle," said Benjamin Schroeder, rate strategist at Commerzbank in Frankfurt.
Despite increased investor tension over Italy and the lingering question of whether Greece would need to restructure its debt, markets showed little doubt that the European Central Bank would follow through with the rate hike signalled for July. Eurozone inflation came in at 2.8 percent in April, above the ECB's target, and the German Bundesbank's new chief warned on Monday of the upside risks to long-term inflation expectations.
December Euribor futures rose 6 ticks on the day to 98.065, the highest since March 18, pushing the implied three-month Euribor rate for the end of the year to 1.935 percent. Technical charts showed an inverse head and shoulders pattern forming - a signal that the rise could extend further, to test the levels reached on March 16 around 98.235.
"The head is the lowest point which we hit in April, and what we're doing since last Friday and into this week is we're trying to break through the neckline of this inverse formation," said Nicole Elliott, technical analyst at Mizuho Corporate Bank. "I am suggesting the measured targets from all of this would be the height of the head which should get us back up to that squeeze we had in March." Analysts said the repricing of rate hike expectations was a short-term move, reflecting an increased risk that sovereign woes could slow the ECB's plans, but that this was not yet seen as the central scenario.