The turmoil in recent statements… The ECB's latest statements, which do not exclude rate hikes, show that the focus has shifted to the inflation side. Risks to inflation are significantly upside, especially in the short term, which has caused the ECB to abandon the rhetoric that there will be no rate hike in 2022. The outlook will become a little clearer with the projections to be updated in March.
The concept of inflation… The focus of ECB policy makers in their February monetary policy announcements was definitely price pressures that could be permanent. CPI inflation remains high, at 5.1% year-on-year in January, the highest since the EUR was launched. While most of the increase is due to energy, core inflation trends point to a broad-based inflation spillover. Therefore, oil is not the only reason for the acceleration in inflation. Since the stagnation in prices has not ended, headline and core inflation may renew the peak.
March meeting and changing policy projections… The ECB did not change its monetary policy stance, but Lagarde's statements at the press conference were a bit more hawkish than before. Markets seem to have entered an early pricing phase, with expectations building that the ECB may raise interest rates by the middle of this year. In its current form, it seems that a controlled tightening path will be entered until 2023 at the latest.
More hawkish comments are also coming from other ECB executives. We observe that inflation pressure has made the rate hike event, which was not talked about two months ago, as the baseline scenario for this year. Central bank signals can be expected to emerge more clearly in the March 10 monetary policy announcement. The first moves to move the deposit rate out of the negative zone towards the end of 2022 may come.
ECB interest rate movements OIS projections… Source: Bloomberg
The differentiation with the Fed… While the Fed begins a rapid tightening against inflation, it will also follow the economic growth rate in the upcoming period. The slowdown in growth will cause the Fed to slow down or switch to automatic mode, while rapid inflation and steady growth will cause the Fed to tighten rapidly. The Fed is likely to start shrinking its balance sheet in the middle of this year.
The ECB will likely adjust the rate of rate hikes a little bit faster than previously projected, but the point of aggressive progress as the market is currently pricing is not very clear. We would expect the ECB to lag a little further behind the Fed's pace. Crisis expectations are also an important factor here. The increase in the margin of policy error in the risks of slowing down global growth will lead to a more gradual and data-dependent continuation of the following period. While we see the increase in the deposit rate at one stage immediately after the end of bond purchases will be the baseline scenario, we think that the current policy stance points to a gradual tightening in 2023.
Negative yield bonds and spreads… Increasing expectations of rate hikes after the ECB meeting triggered the rise in EU bond rates. There is no serious expansion in spreads yet. The tightening difference between the Fed and the ECB is decisive for the situation in spreads. The ECB could set the stage for a rate hike by announcing it will cut bond purchases more quickly at its March meeting. It is priced that there may be an action leg in the interest rate towards the middle of the year. Tightening expectations also reduce the negative yield bonds around the world. It is an important transformation that the Euro Zone interest rates have turned positive on the long-term side as well. The rapid increase in US interest rates may cause many countries to reduce their bond stocks due to strategic asset diversification.
The movement of the 10-year bond yields of the main developed countries from the negative or low region (Germany, Japan, Switzerland, Sweden)… Source: Bloomberg
Conclusion? Policymakers are increasingly concerned about fixing inflation expectations regarding ever-increasing price pressures. Inflation is likely to increase further in the near term. Asset purchases will likely be terminated shortly before the ECB raises rates. We are still not at a firm guidance point on the timing of the first rate hike and the markets are loading somewhat aggressively. In terms of interest rate increases, we foresee a slightly more gradual path.
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