Investors underpricing ECB rate hikes, Knot says

FRANKFURT (Reuters) – Markets may be underestimating planned rate hikes by the European Central Bank and most of the remaining increases will be done in multiples of 50 basis points, Dutch central bank chief Klaas Knot said on Thursday.

The ECB flagged a steady pace of 50 basis point rates hikes in the months ahead but investors have started to price out some of those moves, anticipating smaller increases and a lower peak in interest rates.

“It will not stop after a single 50 basis point hike, that’s for sure,” Knot told CNBC, adding that investors should take more seriously its policy guidance. “Most of the ground that we have to cover, we will cover at a constant pace of multiple 50 basis points hikes.”

He added that the ECB will keep on tightening policy at least until mid-year and current market pricing of rates is inconsistent with the bank’s aim of cutting inflation to its 2% target from levels around 10%.

“The sort of market developments that I’ve seen over the last two weeks or so, are not entirely welcome,” Knot said after investors priced out some rate hikes. “I don’t think that they are compatible, actually, with a timely return of inflation towards 2%.”

Knot said that for the time being, the bank was only focused on the risk of tightening policy too little and a more balanced risk perception is still some time away.

Knot added that benign growth data suggests that the 20-nation currency bloc could avoid a recession over the winter but growth will be weak, nevertheless.

Markets now see the ECB’s 2% deposit rate rising to around 3.2% by mid-year, a big downgrade from levels around 3.5% priced at the turn of the year. While a 50 basis point hike for February is fully priced in, markets are oscillating between 25 and 50 for March.

Part of the change is related to more benign rate hike expectations from the U.S. Federal Reserve and an anticipation that the ECB would follow its U.S. counterpart if its slowed or stopped with rate hikes.

But while U.S. inflation has likely peaked, euro zone inflation could still tick higher and core inflation, which filters out volatile food and fuel prices, is still going up.

“Core inflation shows no signs of abating,” Knot said. “I would first need to see different dynamics in core inflation before I could start thinking about a more equal balance of risk.”

(Reporting by Balazs Koranyi; editing by Jason Neely and Toby Chopra)