ECB Monitor: Hawkish Tone Meets Hawkish Forecasts

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Summary

• Following the ECB’s more hawkish shift in their forecasts at the last meeting, tone has followed suit.
• Speakers are rallying behind the need to hike further, July is now a given, September looks increasingly likely – 4% terminal rate (as we have long expected) looks like the base.
• We continue to see value in positioning for 6M fwd 1Y EUR OIS rising further.
• Data and surveys continue to support further hawkishness. While core and services inflation momentum slowed in June, there is strong capacity for a reacceleration come July.

Current ECB Forecasts

Link to Most Recent ECB Meeting Minutes (May 2023)

ECB Forecasts Turn (Finally)

What a difference a month makes. We have long expected that the ECB would need to hawkishly revise their forecasts (hence the ‘finally’). Yet, we were still caught out by their last meeting. The writing on the wall seemed to indicate they were happy to kick the can (recall: Lagarde’s ‘cruising altitude’ comments). Clearly, this was not the case.

Instead, the forecasts have shifted much more hawkish. The inflation outlook now actually makes sense, but there remain some risks to the outlook, particularly from the labour market side.

We have been hawkish the medium-term inflation outlook for some time on account of support from the labour market, fiscal looseness, and likely elevated energy prices (beyond the near-term).

From the ECB’s side however, while fiscal looseness has been criticised, the upwards revision to core inflation predominantly reflects an upward revision to unit labour costs (on account of low productivity growth), something that Lagarde has confirmed (Chart 1).

While part of this rise in ULC is on account of the higher wage growth and low expectations of productivity, the expectations around unemployment rate have also been revised markedly lower – with the profile for the next 3 years now on a downward trajectory across the horizon – the first time since December 2021 (Chart 2). While the ECB has been overly negative about the unemployment rate for much of the period since, given the recent decline in hiring expectations for manufacturing firms, the assumption that employment growth persists across the next three years is a risk.

ECB Speakers Rallying Behind Need to Hike More

The newly hawkish forecasts have been matched by comments from the speakers, with the doves either rallying behind a July, and perhaps September hike, or else staying quiet on the matter (the exception being Portugal’s Centeno who has wanted to pause for a while).

July is now ‘fait accompli’ (de Guindos’ words), while most have rallied around September being data dependent (Chief Economist Lane, Spain’s de Cos, Estonia’s Müller, Slovakia’s Kažimír, Greece’s Stournaras to name a few). However, the hawks have put a pretty high bar on what ‘data’ would be needed to justify a September pause. Belgium’s Wunsch sees it needing three consecutive core drops (already highly improbable given Friday’s preliminary June inflation outturn (a 0.1pp rise to 5.4% YoY).

Some Reshuffling Ahead in the ECB

Looking ahead, there will be several reshuffles in the ECB. Executive Board Member Fabio Panetta is set to replace Visco as head of Italy’s NCB in October. The expectation, for now, is that the Italians will get the chance to pick Pannetta’s replacement on the Board. If that is the case, expect another dove, given the comments against further hiking from Italian PM Meloni, and her junior coalition partner, Salvini.

Meanwhile, longstanding ECB member Olli Rehn (Bank of Finland) has announced he will go on leave, after throwing his hat in the ring for the January 2024 Finnish Presidential election. In the meantime, his responsibilities at the ECB will be covered by Bank of Finland board member Tuomas Välimäki.

Market Pricing in 4% Terminal

The market is now pricing our longstanding expectation for the ECB terminal rate to be at least 4% (Chart 3). However, they continue to price relatively early cuts. More likely, we will see the ECB hike to that point (or perhaps slightly higher) and pause there for some time. This should allow the 6M fwd 1Y EUR OIS to continue to rise.

ECB speakers are increasingly pointing towards the possibility of a September hike (Chart 4). This is in contrast to the theme we found at the start of June, when a 3.75% ECB terminal rate seemed the strong preference.

The June preliminary Eurozone CPI outturn was not suggestive of a particularly strong services or core MoM (Charts 5 & 6). Instead, it reflected more the base-effects from last June (when German transport subsidies were first introduced) falling out. However, as we cautioned before the release, June typically sees relatively little re-pricing activity in firms. Instead, July, which typically sees large discounting in core, and large price rises in Services (Chart 7). Offers a stronger possibility to see a YoY rise if firms choose to increase (or reduce) their typical July price rises (or discounts).

See here for our full table of recent ECB comments

Surveys and Financial Conditions Support Hawkishness

We find that surveys and data important to the ECB (in our appendix) remain hawkish, albeit they are becoming somewhat more balanced:

• EZ systemic stress has begun to stabilise – it is higher than pre-hiking, but decently down from H2 2022 highs or the highs seen post-SVB (Chart A1).  HAWKISH
• Market pricing is now looking for a terminal rate around 4% (our base case), however there is little upside priced currently to this (1pp cut priced between 12 and 24 months). There is room for this to rise further (Chart A2). HAWKISH
• Data surprises continue to collapse in the EZ. They are now more negative than any time outside the Covid crash (Chart A3). DOVISH
• Consumer confidence continues to recover (albeit it remains at low levels), while overall expectations of business orders have dipped back down (Chart A4). DOVISH
• Hiring expectations paint a more positive picture, with services supporting the overall metric (Chart A5). Even so, the divergence between it and ECB expectations for continued labour market tightening is quite extreme (Chart A5). MIXED
• Finally, inflation expectations remain de-anchored from pre-2022 levels. While there has been some paring in analyst expectations, and consumer expectations have been volatile recently, the trend is significantly above historic average (Chart A6). HAWKISH

Recent Voter Comments

Appendix: Stress, Surveys and Economic Data

Henry Occleston is a Strategist, who focuses on European markets. Formerly, he worked in European credit and rates strategy at Mizuho Bank, and market strategy at Lloyds Bank.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)