European equities were muted and government bond prices softened as investors anticipated looming eurozone rate rises with downbeat economic growth forecasts.
The regional Stoxx 600 share index edged 0.2 per cent lower in morning trade on Wednesday, following a bumpy session on Wall Street that left the blue-chip S&P 500 index up almost 1 per cent despite a profit warning from retailer Target.
The yield on Germany’s 10-year Bund, which functions as a benchmark for debt costs in the eurozone, added 0.03 percentage points to 1.32 per cent, trading around its highest since 2014.
Italy’s equivalent bond yield added 0.06 percentage points to 3.45 per cent, having almost tripled since the start of the year as the prospects rose of weaker eurozone nations having to grapple with an economic downturn and higher funding costs. Bond yields rise as their prices fall.
The European Central Bank — which has kept its main deposit rate negative since 2014 — is expected to signal plans to return the rate to zero by September to battle soaring inflation while also moving to protect weaker nations in the bloc from financial stress.
“The ECB appears set to hike rates given sticky upward inflation pressures,” strategists at Barclays said in a note to clients, adding that “a path to a soft landing is narrow”.
“The situation the ECB is facing remains very delicate,” said Gergely Majoros, investment committee member at asset manager Carmignac. “The inflation dynamics in the eurozone have to be addressed,” he said, while the economic outlook “has started to weaken significantly”.
With trading in leading currency pairs mostly muted because of a concerted move by large central banks to lift borrowing costs, the yen continued its slide against the dollar to ¥133.78 on Wednesday, down almost 4 per cent so far in June, over expectations that the Bank of Japan will hold interest rates at ultra-low levels.
On Tuesday, the World Bank described global economic conditions as similar to the 1970s, where steep rises in borrowing costs were used to control inflation. Economic output in Europe and central Asia would shrink by about 3 per cent in 2022, the World Bank said, “as the war in Ukraine and its repercussions reverberate through commodity and financial markets”.
In a blog post on May 23, ECB president Christine Lagarde pledged to “take the growth outlook into account when calibrating policy normalisation”, soothing fears of rapid rate rises that would further choke off growth.
Economists at Citigroup warned in a research note, however, that if the ECB’s policy statement on Thursday did not “align” with Lagarde’s blog post, investors should expect “a faster pace of rate hikes”, and a “more erratic” rates policy that could increase the risks of “financial fragmentation” between nations in the euro area.
Asian stocks rallied on Wednesday, mirroring gains on Wall Street in the previous session, with Hong Kong’s Hang Seng index adding 2.2 per cent and Tokyo’s Nikkei 225 up 1 per cent.
Futures trading implied the S&P 500 would edge 0.4 per cent lower in early dealings, however, as uncertainty over the economic outlook and thin liquidity kept Wall Street markets from forming a decisive narrative. The S&P, which often sets the tone for stock markets worldwide, has fallen for eight of the past nine weeks.
