ECB: The Journey Has Begun

Published on April 14, 2022
SGH Insight
...while the ECB has punted the decision on which specific month in Q3 it will end APP purchases until its June 9 forecasting round meeting, as things stand and barring some massive unforeseen shock, we fully expect the last 20-billion-euro monthly round will be purchased in June, and APP will stop as of July 1.

Of course, the last time the ECB hiked rates was in 2011, and a decision as momentous as lift-off into a rate hiking cycle will ideally need to be tied to a forecasting round, no matter how flawed, and that presents an interesting timing dilemma. Namely, with the need to move off negative interest rates so glaringly obvious, can the ECB make a case in June that the conditions are met for the end of APP, but not yet for liftoff in July, and wait another full three months for lift-off?
We’ll see, but we suspect not...

...On a final note, we would like to toss out the “scoop” reported by a wire service about an emergency program in the works at the ECB to stop fragmentation of Eurozone markets as an utter non-story.

Since well before the conclusion of the ECB’s Pandemic Emergency Purchase Program (PEPP) program in April of this year, ECB officials have talked about the desirability of retaining optionality in the case of an emergency to purchase sovereign bonds on a more discretion based, flexible manner, meaning away from the ECB’s self-imposed Capital Key restrictions. The PEPP, of course, did just that.

This appears to have morphed into a wire article about an emergency program in the works evoking former ECB President Mario Draghi, the OMT program, “everything it takes” vows, and other such trips down memory lane and the European debt crisis. Having intervened multiple times in the course of its history to manage fragmentation and spiking yields in times of crisis, one would think the ability of the ECB to do just that if needed would be glaringly obvious to all. Indeed, when asked about it multiple times, Lagarde merely shrugged.

Market Validation
Bloomberg 4/21/22

The European Central Bank should be able to
phase out asset purchases in July to pave the way for an
interest-rate increase as early as that month, according to Vice
President Luis de Guindos.

Any decision will hinge on the ECB’s economic forecasts at
its next policy meeting in June, though it’s already “crystal
clear” that higher inflation and lower growth will be part of
the mix, Guindos said in a Bloomberg interview. He discounted
the chance of a recession and stagflation in the euro area.
“I see no reason why we should not discontinue our Asset
Purchase Program in July,” Guindos said. “

Bloomberg 4/21/22

On concerns that the ECB’s exit path could put more highly
indebted countries in the euro area under pressure and lead to a
new debt crisis, Wunsch said there’s “quite broad” consensus
within the central bank that “unwarranted fragmentation” on bond
markets would be addressed. But he cautioned that policy makers
shouldn’t “over-engineer instruments because we need to be able
to react to specific circumstances.”

European Central Bank President Christine Lagarde noted in her press conference following today’s meeting of the Governing Council that “the journey” towards monetary policy normalization has begun. That means a journey both on asset purchases and interest rates.

This of course has been abundantly clear to markets, where the near-term trading action has revolved around whether the first two Euro interest rate hikes will come at the ECB’s quarterly forecast round meetings in September and December, which as we have written appears to be already a solid — and minimum — baseline consensus forming across the ECB.

The other option is to pull liftoff forward to the ECB’s July 21 policy meeting, which would increase the odds of three rate hikes in the second half of 2022, and markets have traded essentially between two and three 25 basis point hikes for the year.

The ECB’s announcement today that it will be definitively ending the Asset Purchase Program in Q3 of 2022 leaves both those scenarios intact, even though we still do not sense the ECB, with an eye towards exiting the negative 50 basis point deposit rate by year end, has come around to three rate hikes – at least not yet.

With that in mind, the Governing Council, and President Lagarde, did not tilt quite as hawkishly as they could have. That would have been to confirm a hard end in June to the APP, which would have been seen as validating a July hike. The slightly more open-ended “sometime in Q3 end” to APP announcement today has therefore led to some small position adjustments in the very front end of Euro rates trading markets.

But the ECB actions today do not rule out the more hawkish scenarios either.

President Lagarde coyly noted that the third quarter has three months, so ending bond purchases “anytime” in Q3 could mean July, August, or September. Yet the ECB is normalizing, and ECB officials are aware that there is really no reason on earth to continue adding stimulus, with inflation raging above 7%, except to manage the ECB’s sequencing process and rate hike expectations.

And so, while the ECB has punted the decision on which specific month in Q3 it will end APP purchases until its June 9 forecasting round meeting, as things stand and barring some massive unforeseen shock, we fully expect the last 20-billion-euro monthly round will be purchased in June, and APP will stop as of July 1.

As we wrote in SGH 4/4/22, “ECB: The Adverse Inflation Scenario”:

ECB officials note that while communications after the March meeting have indicated the possibility of an accelerated end to the ECB’s bond buying Asset Purchase Program in the third quarter of 2022, that “in” does not mean the end of the quarter, “as some had interpreted,” but could also mean the beginning, in July.

The June decision will be made in conjunction with a forecasting round that will mark inflation for 2022 considerably higher than was forecast in the March round, and that will mark up the outer years as well. However, as we have also written and the ECB Minutes revealed, the conditions for lift-off are already abundantly clear, and perhaps more to the point, the ECB is moving away from decision-making based on the fine-tuning of staff forecasts by its chief economist Philip Lane.

Indeed, Lagarde gave kudos to the ECB staff for a good effort and pointed to the uncertainties of war as a reason for the staff’s consistent underestimation of inflationary pressures (which truth be told started three months before the war). Most importantly, she said the ECB cannot be “exclusively riveted” to its models, and that there would need to be an “element of judgment” in its normalization decisions.

Of course, the last time the ECB hiked rates was in 2011, and a decision as momentous as lift-off into a rate hiking cycle will ideally need to be tied to a forecasting round, no matter how flawed, and that presents an interesting timing dilemma. Namely, with the need to move off negative interest rates so glaringly obvious, can the ECB make a case in June that the conditions are met for the end of APP, but not yet for liftoff in July, and wait another full three months for lift-off?

We’ll see, but we suspect not.

On a final note, we would like to toss out the “scoop” reported by a wire service about an emergency program in the works at the ECB to stop fragmentation of Eurozone markets as an utter non-story.

Since well before the conclusion of the ECB’s Pandemic Emergency Purchase Program (PEPP) program in April of this year, ECB officials have talked about the desirability of retaining optionality in the case of an emergency to purchase sovereign bonds on a more discretion based, flexible manner, meaning away from the ECB’s self-imposed Capital Key restrictions. The PEPP, of course, did just that.

This appears to have morphed into a wire article about an emergency program in the works evoking former ECB President Mario Draghi, the OMT program, “everything it takes” vows, and other such trips down memory lane and the European debt crisis. Having intervened multiple times in the course of its history to manage fragmentation and spiking yields in times of crisis, one would think the ability of the ECB to do just that if needed would be glaringly obvious to all. Indeed, when asked about it multiple times, Lagarde merely shrugged.  

This is unimportant, except that “the emergency facility” unfortunately took up at least three questions from journalists today to President Lagarde and took oxygen away from the real relevant questions than need to be addressed regarding the ECB’s normalization and hiking cycle.

That included a question towards the end of the press conference that was left unanswered regarding the ECB’s view on what might constitute a terminal or neutral rate. While we suspect that answer may not be quite formulated yet at the ECB Board and Council, it is an important question we will be looking at as the ECB embarks on its long-awaited, normalization “journey.”

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