Rising oil prices have reignited inflation concerns, prompting traders to increase their bets on accelerated interest rate hikes from the Bank of England and the European Central Bank.
For the first time in a month, traders have fully priced in expectations for a 25-basis-point rate increase by the Bank of England before September, with another hike anticipated before the year ends.
Similarly, markets are now expecting the European Central Bank to implement a 25-basis-point hike in September, with a further increase by year-end now considered almost a certainty.
This shift in expectations coincides with escalating tensions between the US and Iran, which are pushing Brent crude prices toward $90 per barrel.
At the beginning of this month, swap markets were pricing in less than 25 basis points of total tightening from both central banks through next year.
However, recent actions by the US President to re-impose a blockade on Iranian vessels transiting the Strait of Hormuz and to demand payment for all other cargo have shattered the market's previous calm.
Earlier on Monday, the President claimed control over the Strait of Hormuz, writing on social media, "From now on, the United States will be considered the 'Guardian of the Strait of Hormuz'; as the guardian, and in the name of 'fairness,' the U.S. will impose a 20% fee on all transported goods to compensate for the various expenses necessary to maintain the security and safety of this turbulent region of the world."
Money Markets Boost Bets on Faster Rate Hikes
ING strategist Padraic Garvey noted in a client report, "This pricing partly reflects a balance of risks. The threshold for another rate hike remains high if oil prices stay at current levels; but if oil prices continue to climb, then further tightening becomes more of a baseline outcome."
The region's dependence on energy imports leaves it highly exposed to the risks of surging energy prices.
Although inflation in both the UK and the Eurozone had previously appeared to be turning a corner, the recent spike in oil prices has renewed concerns that policymakers will need to tighten monetary policy.
Traders will be closely watching a scheduled speech by Bank of England Governor Andrew Bailey later on Tuesday for insights into his views on price growth.
He has recently expressed frustration, stating that if a US-Iran war had not erupted, inflation would already be at the central bank's 2% target.
The Federal Reserve is also expected to raise rates in September, with money markets now pricing in nearly a 50% probability of action as soon as this month.
Federal Reserve Governor Christopher Waller stated on Monday that policymakers may need to tighten policy further if underlying inflation continues to signal broad price pressures.
Upcoming US inflation data is expected to show a 0.2% month-on-month increase in the core reading for June.
Investors will then turn to testimony from Federal Reserve Chairman Kevin Warsh for signs of whether he endorses the market-implied path for interest rates.
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