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Investors are anticipating too much tightening from the ECB, BlackRock says

BlackRock is betting that a weakening economy will curb the European Central Bank’s ability to raise interest rates over the next 18 months, as rising food and energy prices put pressure on euro area consumers.

Faced with record high inflation, the ECB is expected to present plans on Thursday to end eight years of bond purchases and negative interest rates as it charts a course that diverges from the stimulus policy of the coronavirus pandemic era.

However, investors have gone too far to anticipate a series of aggressive rate hikes that would push the ECB’s deposit rate to 2 percent by the end of 2023, from its current low of minus 0.5 percent, said Michael Krautzberger, who oversees active fixed income strategies in Europe at the $10 trillion asset manager.

The central bank is right in tackling inflation, Krautzberger said, after consumer prices rose to 8.1 percent in May — but a fragile economy and the sensitivity of government borrowing costs in euro-zone members has risen sharply. high debt for higher interest rates will accelerate the pace of tightening.

“I would say this is a good chance for the ECB to end” [its bond-buying programme] and negative interest,” he said. “But after that I think they may have to slow down. The situation calls for a very careful approach.”

BlackRock has made a money market bet that the pace of rate hikes will slow in 2023 after launching this year. The company is also considering buying two-year German bonds as a bet on a slower pace of tightening, Krautzberger said.

He added that cracks are appearing in the economy even before borrowing costs have started to rise, suggesting that the eurozone will have a limited tolerance to higher interest rates, driving up mortgage costs.

“Consumer confidence in the eurozone is near all-time lows,” Krautzberger said. “The same goes for forward-looking components of sentiment surveys. Walks will have a huge impact on the real estate market.”

The expectation component of the Sentix investor sentiment survey fell to its lowest level in a decade in June, according to figures released this week.

“The underlying problem in [the past] 15 years ago, Europe was unable to sustain the 2 percent growth rate,” Krautzberger said. “Inflation has risen much more than the market expected and much more than I expected,” he added.

“If you look at the reasons why inflation is so high, the majority is really bad for growth – a rise in oil and food prices and broken supply chains. I don’t think there’s anything to indicate that Europe’s growth slump is for good has been overcome.”

In a sign that the ECB is concerned about the possibility of higher interest rates triggering a sell-off in the bond market, the central bank will strengthen its commitment to a new debt-support arrangement for vulnerable countries such as Italy with new purchases on Thursday. The difference between Italy’s 10-year borrowing cost versus Germany’s — a close barometer of bond market stress — has doubled to more than two percentage points in the past eight months.

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