European Stocks Hit Pause Button On Rally Amid ECB Hawkish Remarks, UK Inflation Spike – All Eyes On FOMC

The rally in European stocks stalls after sessions of heightened risk appetite as the ECB sends out hawkish warnings and U.K. inflation picks up once again.

Halfway through the European trading session, investors' anxiety about Wednesday's FOMC meeting has dampened the positive momentum seen in the main European stock indices over the past few days.

Both the Euro Stoxx 50 index, tracked by the iShares MSCI Eurozone ETF EZU, and the UK FTSE 100 index, tracked by the iShares MSCI United Kingdom ETF EWU are flat on the day, after surging by 2.4% and 1.5% respectively on Tuesday.

Eurostoxx 50 Heatmap on March 22, 2023 – Chart: TradingView

ECB Delivers Hawkish Remarks

Christine Lagarde, president of the European Central Bank, said this morning that the fight against inflation is far from done since there is no convincing sign that underlying inflation is heading lower. She also reiterated that there is no trade off between price and financial stability.

"The banking crisis could be a non-event, one of many contributing factors, or it could have a macro influence, but it is just a tail possibility," said ECB Chief Economist Philip Lane.

UK Inflation Spikes Again, Traders Expect BoE To Hike 25bp on Thursday 

On the data front, the annual inflation rate in the United Kingdom surprisingly jumped to 10.4% in February 2023, up from 10.1% in January, the first rise in four months and above predictions of 9.9%. Core inflation also rose faster than predicted (6.2% vs. 5.7%). The most significant contributions came from food and non-alcoholic beverages, restaurants and hotels, café and pubs, clothing and footwear.

Markets have completely priced in a 25-basis-point rate rise by the Bank of England on Thursday.

Euro, Pound Gain, While European Bonds Fall

The euro (EUR/USD) and the British pound (GBP/USD) gained 0.2% and 0.5%, respectively, while European bonds fell due to increasing yields. The 10-year UK Gilt yield climbed by 16 basis points to 3.52%, while the 10-year Bund yield increased by 7bps s to 2.37%. 

All Eyes On The FOMC: What Will The Fed Do After March?

The market currently assigns a probability of 86% that the Fed will increase interest rates by 25 basis points at its meeting today.

Major uncertainties stem from the Fed's path of actions following March. Because of the current upheaval in the financial sector, some market investors fear the FOMC may suspend or perhaps invert its rate hiking cycle. This view is also sponsored by Bill Ackman and Elon Musk.

However, after Treasury Secretary Janet Yellen reaffirmed the government's commitment to support the banking system, concerns about the soundness of the banking industry have diminished over the past few days. The Treasury Department is also investigating the possibility of expanding the FDIC guarantee to include deposits above the $250,000 threshold. If concerns about banks diminish, the Fed may be able to refocus on the inflation-fighting strategy.

The market is pricing in a terminal rate of 5% in May 2023, followed by two fully priced rate cuts of 25 basis points by December 2023. 

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