Citigroup stated that market expectations for interest rate increases from the two major central banks are currently converging, but their policy approaches have shown clear divergence during last week's monetary policy meetings. The bank advises betting that the European Central Bank will raise rates more than the Bank of England.
In a client research report issued on Wednesday, Jamie Sear, a strategist at the U.S.-based bank, wrote: "Although the Bank of England indicated it would hike if geopolitical conflicts worsen, under the baseline scenario, both the probability of its rate increases and the likelihood of delivering the market-priced hike magnitude are significantly lower than those of the ECB."
He recommended going long on the July 2026 Sterling Overnight Index Average (SONIA) linked to the UK Monetary Policy Committee and shorting the July 2026 Euro Short-Term Rate (ESTR) tied to the ECB, entering at a spread of 174 basis points, targeting 158 basis points, with a stop-loss set at 182 basis points. He highlighted risk scenarios where the two central banks move in complete sync, or where the Bank of England ends up hiking more than the ECB under extreme adverse conditions.
"Aside from differing starting points (the ECB is in a neutral policy stance while the BOE is already leaning restrictive) and varying sensitivity to economic downturns (the BOE places greater emphasis on policy trade-offs), the two also exhibit distinctly different approaches in terms of how much they allow markets to digest policy impacts independently."
"For the ECB, the baseline economic outlook already incorporates market pricing for rate hikes, meaning the central bank is highly likely to follow through with increases (even if avoiding severe negative scenarios). In fact, the ECB has sent clear signals that a June hike is very probable."
"Meanwhile, the Bank of England noted that although policy rules suggest current interest rates need to be higher than in February, market rate paths have already risen by an average of about 55 basis points. Moreover, the withdrawal of 40 basis points of priced-in rate cut expectations is likely sufficient to cover risks under the bank's Scenarios A and B, making further hikes unnecessary."
The Bank of England "would only consider significant rate increases under the more severe Scenario C."
"The key point is this: the policy focus is on withdrawing 40 basis points of rate cut expectations from the market path, not repricing an additional 40 basis points of hikes."
Citigroup's economics team baseline forecast expects the ECB to hike rates by 25 basis points each in June and July, totaling two increases, while the Bank of England is projected to keep rates unchanged.
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