Different playbook for UK and EU rates
By comparison, UK and EU rates may be capped due to the limited capacity of the domestic economies to absorb higher financing costs. While the Bank of England (BoE) started the rate-hiking cycle before the Fed and the European Central Bank (ECB), the path may not be as aggressive.
BoE governor Andrew Bailey was brutally honest in May, acknowledging that record-high inflation will take its toll, especially on the consumer. The central bank is likely to raise rates towards 1.5% as a minimum this year, but may hesitate to hike into the next recession. The bond market will be torn between inflation and stagnation risks, leaving room for a wider range outcome for UK rates. By the end of the year, should growth risks translate into lower inflation, rates could decline again.
Eurozone growth seems equally challenged, but more from manufacturing being hit by worsening supply bottlenecks. That said, the ECB president, Christine Lagarde, has already prepared the market for rate hikes that are likely to start in July and continue until the end of the year.
While the market is priced for more hikes, the central bank needs to keep an eye on financial conditions. Tighter financial conditions could be a problem, especially for Italy, for example.
Given the market is priced for several rate hikes, which has pushed the front-end of the curve well into positive territory, there seems to be an opportunity to lock in short-term positive yields.