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Moves in the Euribor strip seem at odds with EZ 5y5y inflation (1/2)

EURO SUMMARY
  • Eurozone 5y5y forward inflation swaps continue to drift higher. The levels around 1.90% we have seen over the past few days are the highest that have been seen since 2015.
  • At the same time the Euribor strip has been moving lower today with zero rates now fully priced by early 2024 and 20bp of hikes almost fully priced for next year.
  • So markets are pricing in a much faster normalisation of rates by the ECB than a few weeks ago.
  • Perhaps this is because hikes are expected this year by the Bank of England and around September next year by the Fed. Or perhaps it is because the ECB hiked in July 2008 as energy prices were rising in what is now viewed as a policy mistake with the global financial crisis already in its early stages.
  • But have things changed now or will the ECB hike rates again in response to rising energy prices? Firstly, there have not really been any ECB speakers discussing ECB rate hikes. The end of PEPP, yes, but even here there seems to be a view that the APP will probably need to be made more flexible and potentially expanded in March. These aren't the noises of a central bank that seems to be planning rate hikes any time soon.
  • Second, the ECB now has a symmetric inflation target. In the past it made sense for 5y5y inflation swaps to be capped around 1.80-1.85% as the 2% inflation target was a ceiling. Now, an inflation overshoot will be viewed in the same way as an inflation undershoot. So inflation expectations should really be closer to 2% than the 1.90% level currently seen in 5y5y inflation swaps.
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