Euro rallies as traders brace for central bank rate hike

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The euro rallied and short-term eurozone government debt came under pressure on Tuesday as traders braced for the bloc’s central bank to raise interest rates for the first time in more than a decade.

The common currency rose 1.2% to just under $1.03, after slipping to parity with the dollar last week for the first time in 20 years as the greenback strengthened and worries intensified with regard to Europe’s dependence on Russian energy.

In government bond markets, the yield on German policy-sensitive two-year bonds rose 0.07 percentage points to 0.59%. The yield on the 10-year German Bund, considered a proxy for eurozone borrowing costs, rose 0.03 percentage points to 1.24%. Bond yields rise as their prices fall.

The European Central Bank widely announced that it would raise its main deposit rate on Thursday, currently at minus 0.5%, for the first time since 2011.

But its policymakers are expected this week to address the possibility of raising interest rates by half a percentage point, topping their own forecasts in the face of record inflation.

The ECB has kept its main interest rate below zero to stimulate lending and spending since 2014, when the eurozone faced a sovereign debt crisis, and fell behind the US Federal Reserve and the Bank of England in monetary policy tightening.

“The fact is the ECB is well behind the curve and has a lot to do,” said Paul O’Connor, head of the UK-based multi-asset team at Janus Henderson. “So it won’t seem unusual for them to start with a 50 basis point hike.”

The yield on two-year Italian bonds added 0.06 percentage point to 1.45%.

In stock markets, the European Stoxx 600 stock index traded steadily.

Futures trading indicated that Wall Street’s S&P 500 would gain 0.8% at the New York open after closing down 0.8% on Monday.

Global stocks have fallen around 20% this year as investors debate central banks’ ability to rein in soaring inflation without pushing economies into contraction, while the quarterly corporate earnings season sparked worries about a possible recession.

Wall Street banks JPMorgan and Morgan Stanley missed analysts’ earnings forecasts last week. On Monday, Goldman Sachs warned it would slow hiring while Bloomberg reported Apple was poised to do the same.

“We are going to see significant downward revisions to earnings forecasts and there is no monetary policy support to help the markets, so it is difficult to be optimistic,” said Luca Paolini, strategist Chief at Pictet Asset Management.

“The only thing that could save the situation is an improvement in China.”

As many as 41 Chinese cities are now closed or under district-level control, Japanese bank Nomura said, as the country pursues its zero-Covid policy while scrambling to develop an effective mRNA-based vaccine.

China’s economy grew just 0.4% in the quarter to June year on year, largely missing analysts’ forecasts, although the weak performance fueled speculation that Beijing would launch stimulus measures .

Hong Kong’s Hang Seng stock index closed down 0.9%, taking its year-to-date loss to 12%.

Tokyo’s Topix gained 0.5%.

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