ECB Watch: The unsaid often weighs more heavily
At first glance, the first ECB meeting of the year appears unspectacular. As expected, key rates remained unchanged and the balance sheet path was confirmed. What was striking, however, was that both the monetary policy statement and the following press conference failed to take a bold position against the market's rate cut bets. Instead, the data-driven approach was emphasized by the ECB. Yields and swap rates in the euro area fell markedly as a result.
Market prices early turnaround of the rates cycle - ECB is not too eager to push against it
As expected, the ECB left its key interest rates unchanged at 4% (deposit rate) and 4.5% (main refinancing rate) at today's monetary policy meeting. The last key rate increase took place in September, at that time due to upside risks to the ECB's inflation outlook. Since then, inflation has developed favorably. By and large, the disinflation trend reflected the ECB's expectations. This was also welcomed at the meeting, where the medium-term inflation outlook was seen as confirmed. Further, the monetary policy statement did not contain any cautionary words about excessive inflationary optimism on the market. It was only at the press conference that President Lagarde emphasized potential risks, but here she fell short to meet hawkish expectations.
The effect of monetary policy is felt and is weighing on domestic demand! This was emphasized once again. "Past interest rate increases keep being transmitted forcefully into financing conditions", the ECB said. Even though the ECB has a moderate outlook for the euro area economy, it is likely that the actual economic development will fall short of the ECB's expectations. Without publishing a new forecast - this will only happen in March - the ECB points to downside risks, but remains positive about the medium-term outlook.
There was nothing new with regard to balance sheet policies. The gradual exit from PEPP was already decided in December. As a reminder, maturing bonds in the PEPP portfolio will continue to be fully reinvested until mid-2024. Only then will reinvestments be reduced and discontinued at the beginning of 2025. This was confirmed. The bond portfolios will be reduced "at a measured and predictable pace". The balance sheet reduction is therefore on autopilot.
On markets, the release of the monetary policy statement was reflected by falling yields and swap rates. Due to the lack of cautionary words, the general optimism towards imminent rate cuts was nourished. Furthermore, there has already been a correction in very aggressive positioning since the beginning of the year, which has limited the likelihood of a pronounced hawkish repricing. We consider the market reaction to be plausible, as we also expected the ECB to take a more pronounced stance against early rate cut speculation. Apart from the immediate market reaction, the current market expectation of a first rate cut in April still seems very ambitious to us.
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Franz ZOBL
Austria Franz joined Raiffeisen Research's Economics, Rates, FX team in 2020 primarily focusing on US monetary policy, benchmark yields and EUR/USD. Prior to joining RBI, he worked as a research economist in the financial sector. He holds a PhD from the London School of Economics and studied at the Vienna University of Economics, the University of Vienna as well as Tilburg University. He is a published author within the field of macroeconomics and has a passion for economic history.
The upcoming ECB meeting might seem comfortable for the ECB, as inflation develops broadly as expected, the terminal key rate levels have finally been reached and more clarity on the 2024 balance sheet path has already been created in December. On markets, however, the wind has turned quickly and the ECB got in the defensive of why not to cut key interest rates rather soon. Here are 5 things we expect for the upcoming ECB monetary policy meeting: ► Key rates will be kept unchanged and the ECB will push back against markets' rate cut bets to prevent a pre-emptive loosening but won't change its data dependent forward guidance. ► The ECB will be pleased with recent inflation numbers, which came in broadly as expected and even a touch below projections. Still, expect a word of caution on inflation. ► The ECB will take note of the fact that the euro area economy is performing weaker than expected. A recession is no surprise for most but was not part of the ECB's base case. ► After the surprise decision on PEPP in December, the ECB will confirm that its balance sheet reduction (QT) is on autopilot, which lowers uncertainty for markets ► Talks about the minimum reserve requirement ratio have abated, yet a 'normalisation' to 2% can come at any time, also at the upcoming meeting. |
After years of crises, hopes for 2024 are somewhat clouded, not least due to the geopolitical circumstances. (Geo)politics and interest rate cuts are the buzzwords for the new year on the currency markets, with the former representing potential upward pressure for the safe havens CHF and USD. In Poland, local politics put pressure on the exchange rate. The Albanian lek remains strong backed by fundamentals. Finally, while the rouble showed its stable side recently, supported by several factors, the NBU had to break a devaluation trend. This issues features
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The interest rate market is leaving "high for longer" behind and is preparing for interest rate cuts. Inflation optimism is spreading! We expect a rather gradual decline in core inflation and a wait-and-see approach by the ECB. Yields correcting to the upside over the near-term seems legit. |
Unchanged key interest rates but a decision on a phased exit from PEPP - that was the ECB's December meeting. PEPP reinvestments will be reduced from July 2024 and ended at the beginning of 2025 - a cautious compromise. The inflation outlook is more optimistic than in September, but more pessimistic than priced by the market. Interest rate cuts are currently not a topic for the ECB and President Lagarde was visibly more eager than Fed President Powell to oppose aggressive bets on rate cuts. The dovish Fed was followed by a hawkish ECB, but swimming against the tide is notoriously difficult. |