Below is a comment by Frederik Ducrozet, Head of Macroeconomic Research, and Nadia Gharbi, Senior Economist at Pictet Wealth Management following yesterday's ECB meeting.
We don’t have much to add to our preview below, after the ECB delivered a well-flagged 50bp rate hike while committing explicitly to another 50bp hike in March. Of course, the irony is palpable, having dropped forward guidance last year, only to commit to “significant” hikes at a “steady pace”, including another 50bp hike next month. And if it’s “not irrevocable”, as President Lagarde argued, then what is the point of the commitment in the first place?
But there is much more to say about the market’s dovish reaction to the ECB’s press conference, including some similarities with the Fed and the BoE. Neither of these central banks was dovish. But all of them weren’t more hawkish than expected. In particular, Lagarde, Powell and Bailey did not push hard enough against market pricing to move expectations. It was much easier for central banks to shape market expectations in the early stage of the tightening cycle. It looks much more difficult for them to push back against rate cuts expectations on the way down, although Lagarde gave it a try, insisting on the ECB’s commitment to “stay the course” as the central bank’s job is “not done”.
Despite that commitment, a number of new elements contributed to leave a dovish aftertaste:
First, as we expected, the ECB did not commit to any specific rate path beyond March. Future decisions will be data dependent, as they should be. In the ECB’s own words, the Governing Council (GC) “will evaluate the subsequent path of its monetary policy” following a meeting-by-meeting approach.
Second, the ECB adjusted its risk assessment noting that both risks to growth and to inflation had become “more balanced”. As for inflation, this was a surprise and may well prove premature, although Lagarde subsequently added that the disinflationary process was not yet at play (poke Jay Powell).
Third, the ECB acknowledged the effective transmission of its monetary stance via the credit channel, with Lagarde pointing to weaker credit flows and the Bank Lending Survey several times.
Fourth, the ECB will continue to closely monitor wages, but the lack of stronger emphasis on inflation expectations suggests that the Survey of Professional Forecasters, to be published tomorrow, should follow inflation breakevens and other surveys lower.
Fifth, Lagarde’s insistence on the need for compromise and consensus suggests that there may be growing disagreement among GC members. Some dovish GC members have already called for a more gradual pace of tightening as rates become restrictive. Lagarde’s focus on consensus building would be consistent with a more cautious approach beyond March, unless core inflation continues to surprise to the upside.
On Quantitative Tightening (QT), the ECB published some further guidelines related to the partial reinvestment of its Asset Purchase Programme (APP), which will result in average €15bn reduction of holdings per month. Since the monthly redemptions of APP holdings will exceed the €15bn target between March and June 2023, the remaining reinvestment amounts will be allocated proportionally to the share of redemptions across each programme (PSPP, ABSPP, CBPP3 and CSPP). As for corporate bonds (CSPP), the ECB decided to tilt reinvestments towards issuers with a better climate performance, aka Green QT.
In the end, market participants should now focus firmly on economic data, starting with core inflation dynamics at the start of the year. The latest evidence has been mixed, to say the least, with no signs of a sustained easing of underlying price pressure yet. The more resilient the economy, or the more accommodative the fiscal stance, the higher the chances that the ECB will have to tighten above market expectations this year.
Our baseline remains unchanged for the ECB. We expect the central bank to raise the deposit rate to 3.50% in May, with a risk that they step down to 25bps rate hikes at some point.
