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

* 9MF3M at the €STR OIS curve (transformed to reflect ECB depo rate)
Source: LSEG, RBI/Raiffeisen Research

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

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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.