As we reported yesterday, today's closely-watched European Central Bank decision will be all about what the bank intends to do next, as the end of QE is seen as a near certainty, paving the way for a rate hike at the July meeting (and potentially some form of QT). Traders will also closely follow Lagarde's press conference for signs about the size of the July rate hike and the subsequent policy path. Markets are pricing in about a 40% chance of a 50 basis point move next month. Today's announcements will also include the bank's quarterly economic forecasts which may show inflation above target through 2024.
Here is an extended preview of the ECB's decision:
- At the press conference that follows the meeting, President Christine Lagarde is likely to flag the ECB is poised to increase the deposit rate in July and again in September, although she probably won’t come down on whether the hike will be 50 or 25 bps in July. Debate will continue among members of the Governing Council throughout the weeks ahead, but the press conference should give more color on where the balance currently lies.
- Bloomberg economists forecast 25 bp increases in July, September and December as well as one each quarter thereafter until the main refinancing rate hits 1.5%, the estimate of neutral.
- The ECB’s inflation forecasts will be revised up significantly to show a higher and, probably, later peak this year. Near-term GDP growth should be revised down. Revisions to the medium-term inflation outlook are likely to be smaller.
- The Governing Council will almost certainly announce June as the final month of net bond buying through the Asset Purchase Programme.
- Bloomberg expects the interest rate on the targeted longer-term refinancing operations to be increased by 50 bps in June as the need for cheaper funding will soon pass.
For those seeking some more last-minute hints on how to trade the ECB announcement, courtesy of Bloomberg here are the four things rates and currency traders will be looking for.
End bond purchases, signal lift-off, TLTRO:
- The statement will announce that the ECB’s net buying under its asset-purchase program will conclude this month. That will pave the way for the monetary authority to raise rates next month, in effect keeping its long-standing promise that an end to its asset purchases will precede an increase in the benchmark deposit rate
- The ECB also intends to conclude the “special conditions” applicable under TLTRO III. Essentially, that means banks can no longer tap cheap financing at rates up to 50 basis points lower than its deposit rate
Pace of tightening:
- To say that ECB pricing has evolved this year would be the mother of all understatements. Essentially, we have gone from pricing no rate hikes to factoring in tightening worth five full hikes by year-end
- The ECB hasn’t pushed back on this pricing, essentially serving as tacit approval of the market’s stance. The monetary authority under President Christine Lagarde is keen to exit the era of negative rates, a span that hardly produced meaningful inflation in any case
- The magnitude of a hike in July is a persistent point of client conversation, though the ECB will almost definitely not make any explicit mention of this aspect in its statement. Lagarde will no doubt be asked about this during her press conference. I doubt she will commit to either option and instead reiterate that “the ECB will be data-led.” As things stand, markets are pricing in 36 basis points of an increase on July 21
- While the ECB is likely to revise up its inflation forecast for this year from 5.1%, of crucial import to markets will be what it does with its estimate of 1.9% for 2024. A shift higher in the end-of-horizon forecast will be a hawkish sign and cause rates to sell off
- Also scrutinized will be its economic growth forecast 3.7% for this year, which is likely to be revised lower. The OECD has already slashed its assessment to 2.6% for 2022
Fragmentation, peripheral spreads:
- The ECB is concerned about how yields in some of the more indebted euro- zone economies will fare as it begins to walk in the direction of higher rates. It already flagged in April that “under stressed conditions, flexibility will remain an element of monetary policy whenever threats to monetary policy transmission jeopardise the attainment of price stability.” This is essentially work in progress, but we should expect to hear about its backstop plan for peripheral spreads in the coming weeks if not today
- For all the concern about fragmentation, yields on Greek and Italian bonds have moved in alignment with bunds, and there is little sign of any panic in the markets yet. This risk may take center stage in 2023, though that will be a story for another day