Traders today firmed up bets that the European Central Bank would pause hiking interest rates in September, as sharp contractions in business activity pointed to deepening economic pain in Europe.
Traders now price in a roughly 40% chance of a 25 basis point move in September compared with a more than 50% chance they saw only yesterday.
That suggests they are leaning towards a pause in the ECB's record-paced tightening cycle that has lifted rates from deep in negative territory to 3.75% in just a year.
German business activity contracted at the fastest pace in over three years in August and much more than analysts expected, data showed today, deepening the downturn in business activity far more than thought across the euro zone.
Britain's business activity meanwhile contracted unexpectedly, raising recession risks.
Bond yields in the euro zone and Britain, recently propped up by a resilient US economy, tumbled.
The euro fell to more than a two-month low against the dollar and sterling dropped sharply as investors also scaled back their expectations for where ECB and Bank of England rates will peak.
"The PMI suggests that it's back to the pre-summer narrative of lower rates," said Danske Bank chief analyst Piet Christiansen.
Hit by the receding rate hike expectations, the euro fell to as low as $1.0804, extending its losses against the dollar this month to 1.7%. It is set for its biggest monthly drop since May.
JPMorgan said it now expects the ECB to pause in September and has postponed its expectation of a final 25 bps hike to October, joining a narrow majority of economists polled by Reuters earlier in August who also expect a September pause.
While expectations were scaled back, traders still expect two more 25 bps rate hikes from the Bank of England, which is tackling higher inflation than the euro zone.
They also still see just under a 60% chance of a 25 bps ECB rate hike by December.
Key to investor expectations from the ECB will be next week's euro zone inflation data.
"There's many indicators that suggest that we could have had the last hike but if you just look at inflation, which is the (ECB's) key mandate that is not a done deal," Christiansen at Danske Bank said.
