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ECB meets this week and is tipped to raise interest rates by 0.75%

Financial market volatility expected to remain high

Financial markets remain extremely volatile of late. Having fallen from 2.16% in June to a low of 1.12% in July, the 3 year swap (fixed) rate ended August back up at 2.11%. Over these 3 months, the daily trading range breached 0.10% on 22 of the 66 trading days. To provide context to how significant this level of volatility is, over the 3 years from 2019 through to the end of 2021, there was not one occasion when a daily move of this magnitude occurred.

The prognosis for trading conditions in September is for volatility to remain high. Yesterday, European gas prices spiked 35% on the open in response to Russia’s decision over the weekend to close the Nordstream gas pipeline. 3 year swap rates jumped 0.05% this morning and this rise in term rates may have been more pronounced were it not for this morning’s release of the closely watched Purchasing Manager Index which showed that economic activity in Germany has fallen to a 27 month low and that across the whole of the Eurozone, activity contracted for the second month in a row.

ECB to raise interest rates by at least 0.50% this week

This combination of rising inflation and declining economic activity places the European Central Bank in an invidious position but won’t deter them from raising rates by at least 0.50% at their policy meeting this Thursday. In fact, with consumer inflation up at 9.1% and producer price inflation at 37.9%, the market is anticipating that an even larger 0.75% rate hike will be delivered.

How high will euribor go?

Borrowing costs are rising quickly. Having set at 0.0% as recently as July, 3 month euribor is already at 0.76%. And with 3-year rates above 2%, it’s evident that the market expects the ECB will continue to tighten at upcoming policy meetings and that euribor will rise sharply into the year end. Recent comments from ECB board members indicate that there is a willingness to tighten interest rates even into an economic slowdown. The Governor of the French central bank recently warned that the ECB is prepared to raise interest rates beyond the neutral rate of interest which implies a willingness to take interest rates above 2%. The question is, how far above?

EURIBOR 3M Sept 1

Currently, the forward curve for euribor implies a terminal peak of 2.26% in 2023 while the forward curves for the equivalent rates in both the US and UK imply terminal peaks in their rates cycles above 4%. In light of hawkish comments from ECB officials, the ongoing energy crisis as well as the market’s projections for interest rates in other major economies, euro borrowers need to ensure that they can cope with interest rates well in excess of 2%.

How are borrowers reacting to rising interest rates?

Having enjoyed a low interest rate environment for over a decade, borrowers (and lenders) are now having to quickly adjust to a very different operating environment. Understandably, we’re seeing some gaps in the level of knowledge about how interest rate hedges are priced and structured and are working closely with clients to ensure that hedging costs are minimised and hedge structures are optimised. Examples of the types of conversations we’re having include:

  • – Benchmarking the price on hedging trade calls between a borrower and their bank to ensure that bank pricing is as tight as possible. This is especially important now given that we are regularly seeing moves over 0.10% in a single day. The earlier we are engaged, the more leverage we have to deliver a better outcome
  • – Structuring Cap profiles to minimise the premium cost
  • – Monitoring market levels for clients to take advantage of favourable price moves
  • – Pre-hedging the future interest rate risk on loans to be drawn or refinanced in the future/ expiring fixed rate loans. This is most relevant for borrowers who have fixed income and risk breaches of interest rate covenants or margin erosion

If any of this resonates with you, or for more information on how Vuca Treasury helps borrowers manage interest rate risk, please contact the team by mailing hedging@vucatreasury.com 

Martin Mulligan

Martin Mulligan

Martin Mulligan is the founder of Vuca Treasury. Since 1994, Martin has structured and sold foreign currency, interest rate and commodity hedges for corporate and financial institutional clients at a number of major banks in Ireland, Australia and the UK.

This blog has been prepared by Vuca Treasury Ltd and is for information purposes only and does not constitute investment advice. The information contained herein is based on materials and sources that we believe to be reliable. However, Vuca Treasury makes no representation or warranty, either express or implied, in relation to the accuracy, completeness or reliability of the information contained herein. Except in the case of fraudulent misrepresentation, no liability is accepted whatsoever for any direct, indirect or consequential loss arising from the use of this document. No client-advisor relationship shall be created as a result of this presentation and/ or your use of the information contained in it. A client relationship shall only arise where you become a client of Vuca Treasury by way of our formal engagement agreement.

How we help?

VUCA's diagnostic process enables you to:

 

     Identifying the true value-at-risk from interest rate exposure

     Benchmarking the price on hedging trade calls

    Monitoring market levels for clients to take advantage of favourable price moves

     Simulated hedge analysis to assess the effectiveness of prior & existing strategies

     Select the optimum hedge counterparty (cost, timeframe, credit rating, etc)

 

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