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Europe | Monetary Policy & Inflation | Rates
Europe | Monetary Policy & Inflation | Rates
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At its last meeting, the ECB laid out a particularly hawkish set of forecasts , in line with our longstanding expectation (Chart 1). I expect 50bp to be delivered at the 2 February meeting and at the March meeting, with likelihood for further hikes thereafter (Chart 2).
Headline Eurozone CPI undershot expectation, but given the fact this was largely energy driven should make it largely immaterial to the ECB. Instead, the more important dynamic ahead is the fact that core inflation has yet to peak, and that upward pressures on medium-term inflation remain strong (wage growth, energy transition and fiscal support in particular).
None of these issues are news to the ECB’s Governing Council (GC), and none of them have improved since the last meeting:
In the near-term, given the upside risks to medium term inflation, it is more likely that worsening market conditions, rather than economic fundamentals, are the reason for more cautious ECB tightening. The risk of a spread blow out on the QT announcement was a reason for 50bp rather than 75bp in December. However, since the last meeting, this risk has dropped. Instead, we have seen a consistent re-tightening across credit spreads, with the brief widening post-December ECB meeting having entirely faded (Chart 5). A large portion of the spread tightening has been on the back of Federal Reserve (Fed) dovishness. Meanwhile, measures of systemic stress remain far from their peak (see appendix). If FOMC dovishness continues next week, it will be easy for the ECB to continue to tighten.
Despite President Lagarde’s assertion that she does not give forward guidance, that is exactly what she has continued to provide at press conferences. The current indication she has provided (in line with my view) is for 50bp hikes to continue in March. While her track record for having to walk-back statements is well documented, at this stage, there is not a lot of reason why she should drop this guidance. She may also hint at continuing to hike thereafter (my expectation), but it is more likely that she falls back to the ‘data dependent’ line while also stressing the difference in stage that the ECB and Fed are at.
In sum, the market continues to under-price the probability that the ECB continues to hike aggressively ahead (Chart 6). A terminal rate 3.5% or higher would be more in line with my view.
At this stage, there is little reason to expect any additional guidance for the pace of QT operations with the €15bn pm run down to be re-evaluated in June. The market is currently looking for the rate to rise to €20bn pm in Q3, and €25bn in Q4. Given the profile of APP maturities, there is not a lot of upside to this in 2023 without active sales (Chart 6). Until the rolldown has begun, and the ECB is satisfied with market reaction, there is little need for guidance to the upside.
Market conditions remain benign, but there is little reason for the ECB to add much colour to the discussion of the QT profile. Even as it stands, heavy net-issuance in the periphery should keep the BTP/Bund spread widening.
Surveys and data on economic performance support continued hawkishness. Economic surprise data increasingly suggests European outperformance versus China and the US, while survey results across expected employment, industry orders and consumer confidence all look to have found a bottom recently (see appendix graphs).
Meanwhile, systemic stress has retreated from the highs, helped by strong stock and bond performance. Finally, inflation expectations are showing more significant signs of de-anchoring. This, alongside accelerating wage growth, could add fire to fears of more persistent inflation pressures.
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