European PMI Seen Disappointing! What Follow-up Action Will the ECB Take?

<p>&nbsp;Traders firmed their predictions on Wednesday that the European Central Bank would hold off on raising interest rates in September, as euro zone business activity shrank more than expected, showing a deepening impact on the economic bloc.</p><p><br /></p><p>Traders now factor in around a 40% chance of a move of 25 basis points in September compared to the more than 50% chance they saw just on Tuesday.</p><p><br /></p><p>This suggests market players are now inclined that the ECB will stop its historic tightening cycle, which has raised interest rates from deep negative territory to 3.75% in just one year.</p><p><br /></p><p>Business activity in Germany shrank at the fastest pace in more than three years in August and far more than analysts had expected, based on data shown on Wednesday. This leads to an indication that the decline in business activity is further than believed.</p><p><br /></p><p>Yields from European zone government bonds are seen as limited due to the resilient US economy. On the other hand, the euro currency fell to its lowest level in more than two months against the US dollar and investors also reduced their hopes that the level of the ECB rate will reach its peak.</p><p><br /></p><p><br /></p><p>"The PMI shows that it is returning to the pre-summer narrative of lower rates," said Piet Christiansen, chief analyst at Danske Bank.</p><p><br /></p><p>German yields, the benchmark for the European region, fell 12 basis points to 2.53%, the lowest since Aug. 10. The euro fell to $1.0812 and 84.93 cents. It has lost 1.7% against the dollar this month.</p><p><br /></p><p>The move on Wednesday brought an indication of how the weaker European zone economy and the outlook for borrowing costs contrasted with the resilience of the United States. Strong US data this month has raised hopes that interest rates will remain high for longer.</p><p><br /></p><p>"We expect the ECB to stop raising rates in September, but it is not clear that inflation is at the level the ECB wants or not," said Mark Wall, chief European economist at Deutsche Bank.</p><p><br /></p><p>Markets also cut their forecasts for further hikes for the rest of the year but still see a near 60% chance of a 25 basis point hike by December which would put the ECB deposit rate at 4%.</p>