European shares subdued as traders weigh prospect of rate rises

European equities were muted on Wednesday and government bond prices softened, as investors tried to balance prospects of looming eurozone rate rises with a slowing economy.

The regional Stoxx 600 share index edged higher in early dealings before trading flat, following a bumpy session on Wall Street that left the blue-chip S&P 500 index up almost 1 per cent despite a profit warning from retailer Target.

The yield on Germany’s 10-year Bund, which functions as a benchmark for debt costs in the eurozone, added 0.02 percentage points to 1.31 per cent, trading around its highest since 2014.

Italy’s equivalent bond yield added 0.04 percentage points to 3.43 per cent, having almost tripled since the start of the year. Bond yields move inversely to prices.

The moves came as analysts attempted to forecast the tone of communications from the European Central Bank following its monetary policy meeting on Thursday.

The ECB — which has kept its main deposit rate negative since 2014 — is expected to signal plans to lift borrowing costs back to zero by September to battle soaring inflation while also being willing to protect weaker nations in the bloc from higher funding costs.

“In the euro area, our economists forecast a mild technical recession at the turn of the year and almost no growth in 2023,” strategists at Barclays said in a note to clients. “Yet the ECB appears set to hike rates given sticky upward inflation pressures,” they said, adding that “a path to a soft landing is narrow.”

On Tuesday, the World Bank cut its forecasts for global growth this year further and described economic conditions as similar to the 1970s, where steep rises in borrowing costs were used to control inflation.

Economic output in Europe and Central Asia would shrink by around 3 per cent in 2022, the World Bank said, “as the war in Ukraine and its repercussions reverberate through commodity and financial markets.”

In a May 23 blog post, ECB president Christine Lagarde pledged to “take the growth outlook into account when calibrating policy normalisation,” soothing fears of rapid hikes that would further choke off growth.

Economists at Citi warned in a research note, however, that if the ECB’s policy statement on Thursday did not “align” with Lagarde’s blog post, investors should expect “a faster pace of rate hikes,” and a “more erratic” rates policy that could increase the risks of “financial fragmentation” between euro area nations.

Asian stocks rallied on Wednesday, mirroring gains on Wall Street in the previous session, with Hong Kong’s Hang Seng index adding 2 per cent and Tokyo’s Nikkei 225 up 1 per cent.

Futures trading implied the S&P 500 would edge 0.5 per cent lower in early dealings, however, as uncertainty over the economic outlook and thin liquidity kept Wall Street markets from forming a decisive narrative. The S&P, which often sets the tone for stock markets worldwide, has fallen for eight of the past nine weeks.

“US stocks have been very rangebound in the last week and a half, and usually, such trading patterns break out in one direction or the other,” strategists at ING wrote in a research note. “After failing to push convincingly higher, we may see a correction lower in the coming days/weeks.”

In currency markets, the euro drifted 0.1 per cent lower against the dollar to just under $1.07. The eurozone currency also gained 0.4 per cent against the Japanese yen, to a seven-year peak of ¥142.4.

Brent crude, the oil benchmark, rose 0.5 per cent to $121.18 a barrel.

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