ECB: Locking in Seventy-Five

Published on June 9, 2022
SGH Insight
To think that 75bp by September 8 is not all but locked in, even as the ECB stresses the importance of data dependency to its next rate hiking decisions, would be to badly misread the guidance and set-up that was provided by today’s policy statement and President Christine Lagarde’s press conference.

As we had written and was highlighted by Lagarde in an unusually frank blog posting on May 23, the ECB leadership’s strong preference has been to lead with a more ginger 25bp rate hike when it lifts off from its -0.5% deposit rate at its next meeting on July 21. Even the more hawkish national central bank governors pushing for 50bp hikes were by and large open to this more modest increment for lift-off, after eleven years of accommodative policy.

The case for such cautious moves in subsequent rate hikes has, however, been increasingly difficult to make as inflation numbers continue to stay uncomfortably high, and certainly in this, the early part of the rate hike cycle where it is abundantly clear that policy is some distance from where it needs to be.

This was especially the case after the awful 8.1% estimate for year-on-year May CPI that was released on May 31, and perhaps even more importantly, the jump registered in May Core CPI from an already problematic annualized 3.5% rate to 3.8%.

Indeed, in response to a question from a reporter today on why the ECB would even be hiking rates when the bulk of eurozone inflation was due to exogenous, imported factors, Lagarde pointed, without hesitation, to the passthrough of energy and supply chain inflation into the system, noting that over 75% of the items in the Eurostat’s CPI basket are now rising at a faster pace than the ECB’s 2% inflation rate target.

And so, while the decision whether to hike by 25 or 50bp at the September meeting has been left conditional on data developments over the interim period, the burden of proof for the ECB not to hike by 50bp – that the medium-term inflation outlook improves – was set deliberately high enough to make 50 essentially a lock for September 8 as well.

Market Validation
Bloomberg 6/21/22

The European Central Bank should exit sub-
zero interest rates in September, Governing Council Member Peter
Kazimir said.
“Negative rates must be history by September,” the Slovak
official told reporters in Bratislava on Tuesday, adding that
there’s a consensus that a half-point hike that month is “highly
probable.”

Bloomberg 6/21/22

The European Central Bank has “good reason”
to start raising interest rates next month, said Governing
Council member Olli Rehn.

“Key ECB interest rates will be raised in July, and a
further rise is expected in September,” Rehn said.
Speaking at a press conference in Helsinki, Rehn said that
next month’s hike will be 0.25 percentage point and that it’s
“very likely” the September step will be bigger than that, given
the outlook for inflation. Gradual increases will then continue,
he said.

The Governing Council of the European Central Bank announced today that it will end its bond buying Asset Purchase Program as expected on July 1, and more importantly for markets, locked in 75bp of rate hikes over its next two meetings. 

To think that 75bp by September 8 isnot all but locked in, even as the ECB stresses the importance of data dependency to its next rate hiking decisions, would be to badly misread the guidance and set-up that was provided by today’s policy statement and President Christine Lagarde’s press conference.

As we had written and was highlighted by Lagarde in an unusually frank blog posting on May 23, the ECB leadership’s strong preference has been to lead with a more ginger 25bp rate hike when it lifts off from its -0.5% deposit rate at its next meeting on July 21. Even the more hawkish national central bank governors pushing for 50bp hikes were by and large open to this more modest increment for lift-off, after eleven years of accommodative policy.

The case for such cautious moves in subsequent rate hikes has, however, been increasingly difficult to make as inflation numbers continue to stay uncomfortably high, and certainly in this, the early part of the rate hike cycle where it is abundantly clear that policy is some distance from where it needs to be. 

This was especially the case after the awful 8.1% estimate for year-on-year May CPI that was released on May 31, and perhaps even more importantly, the jump registered in May Core CPI from an already problematic annualized 3.5% rate to 3.8%.

Indeed, in response to a question from a reporter today on why the ECB would even be hiking rates when the bulk of eurozone inflation was due to exogenous, imported factors, Lagarde pointed, without hesitation, to the passthrough of energy and supply chain inflation into the system, noting that over 75% of the items in the Eurostat’s CPI basket are now rising at a faster pace than the ECB’s 2% inflation rate target.

And so, while the decision whether to hike by 25 or 50bp at the September meeting has been left conditional on data developments over the interim period, the burden of proof for the ECB not to hike by 50bp – that the medium-term inflation outlook improves – was set deliberately high enough to make 50 essentially a lock for September 8 as well. 

Lest there be any doubt, Lagarde laid out clearly in the question-and-answer session that today’s guidance means that if the medium-term outlook for 2024 inflation even remains at 2.1%, already arguably an optimistic forecast barring some rather significant policy tightening from the ECB, the Governing Council will hike by 50bp in September.

This, to us, is an extremely well-crafted compromise between the Council’s hawks and its few remaining doves. It is a compromise for which Lagarde got unanimous support, and which positions the ECB for the rather more aggressive action that we have felt has been so clearly necessary, and for which markets have run well ahead of the analyst community and of the ECB itself. 

On the other hand, markets have been wrong-footed for months now by shockingly bad media reporting to expect an imminent roll-out of a new emergency facility by the ECB to address bond market fragmentation (translation – Italian bond yield spreads).

As we have written many times, in considerable detail and with some frustration as these reports kept rolling in, every ECB official we canvassed on this topic conveyed to us that the  ECB has ammunition in its PEPP reinvestments and elsewhere to address fragmentation if necessary, has been able to address fragmentation successfully in the past on numerous occasions, and is not – repeat not – in the process of rolling out a new stand-by facility.

Today, Lagarde again poured cold water on this media/market unicorn, and that, as might be expected, helped fuel a sell-off in Italian BTPs among other European rates instruments. 

While a polite and collective “what are you talking about” from ECB officials on the roll out of emergency facilities might at some point end this speculation, we suspect there is too much vested in this story yet to fully let it go.

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