Europe waits on potentially record ECB rate hike to fight inflation

By Marc Jones

LONDON (Reuters) - Stocks and bond yields shuffled higher while the euro slipped back under parity on Thursday, as investors waited to see if the European Central Bank would fight runaway inflation later with a record 75 basis point interest rate hike, or go smaller.

A drop in oil below $90 a barrel, growing speculation about Japanese FX market intervention and an expected UK energy price plan later meant traders had plenty on their plates before the ECB's 1215 GMT decision.

The pan-European STOXX 600 index rose a modest 0.2% as cyclical sectors including miners and banks and insurers that benefit from higher interest rates gained between 1.0% and 1.1%. [.EU]

Bond and currency markets showed little definitive direction though. The euro wilted back under 1-to-1 to the dollar following its 15% slump this year [/FRX], while government bond market yields turned higher again after an initial move lower. [GVD/EUR]

Paul Hollingsworth, Chief European Economist at BNP Paribas Markets 360, said markets were largely expecting a 75 basis point ECB hike following recent signals from some of its top policymakers.

"The fact that we are not at the peak of inflation in Europe yet is important here," Hollingsworth said.

"If they do deliver the 75 bps, it is likely that we will see more hikes priced in and we could see the euro rally a bit, but we would look to fade that," he added, due to the upcoming recession and winter energy crisis.

The euro slipped 0.19% to $0.99885, after hitting a 20-year low of $0.9864 earlier in the week.

Britain's pound was also in the red again, with the UK's new Prime Minister Liz Truss set to announce a 100 billion pound ($115 billion)-plus package of measures later to cap soaring consumer and business energy bills.

The extra spending has sparked worries about the UK's debts, although an energy price cap could at least bring the peak in UK inflation down to 10% from 15% BNP Paribas' Hollingsworth estimated.

Having hit its lowest level since 1985 on Wednesday, the pound was at $1.1498, down 0.3% on the day - and like the euro - 15% lower for the year. [/GBP]

FED AHEAD

Overnight, Asian stocks made broad gains as oil prices dropped to levels not seen since Russia's invasion of Ukraine, though China was an exception as weak data signalled more pressure on the COVID-hit economy.

Japan's Nikkei share average jumped 2.3%, breaking through the psychological barrier at 28,000 points for the first time this month as domestic exporters saw boosts from the weaker yen.

MSCI's broadest index of Asia-Pacific shares outside Japan rose 0.3%, while Australia's S&P/ASX 200 gained 1.7%.

Chinese blue chips fell 0.3%, however, after the release of worse-than-expected trade data on Wednesday and an extension of the lockdown in the city of Chengdu that demonstrated no let-up in the country's strict zero-COVID policy.

"Today for Asia it's really a story of whether zero-COVID will continue to impact the Chinese economy, which will of course have a spillover effect in terms of imports," said Gary Ng, senior economist at Natixis in Hong Kong.

Markets were also awaiting a speech by Federal Reserve Chairman Jerome Powell later in the day for signs of any let-up in the U.S. central bank's approach to tackling its rising inflation.

CME Group's Fedwatch tool currently shows that expectations for a third successive 75-basis-point interest rate hike are at about 76%, up from 69% a week ago.

"The markets will probably adopt a wait-and-see approach in the short run," said Ng. "Whether it's 50 or 75 basis points will be important, but the most important thing is really about whether inflation can peak, and what is the rate hike path of the Fed going forward?"

The yen was hovering just below 144 per dollar after weakening almost as far as 145 overnight.

Japan is ready to take action to deal with swift moves in the yen, Deputy Chief Cabinet Secretary Seiji Kihara said on Thursday, repeating the government's verbal warnings as the currency hovered around 24-year lows.

"We're worried about rapid and one-sided moves in the currency market," Kihara told a news conference. "If such moves continue, we would like to take necessary action," he said, fanning speculation of possible FX market intervention.

The dollar index, which tracks the greenback against a basket of currencies of other major trading partners, was up slightly at 109.73.

Oil prices recovered slightly from an overnight plunge but remained below $90 a barrel for the first time since early February on worries about global recession risks. U.S. crude down 0.5% to $81.51 a barrel, while Brent crude drifted back to $87.38 per barrel in early European trading.

 

(Additional Reporting by Sam Byford in Hong Kong; Editing by Raissa Kasolowsky)