European Central Bank (ECB) Meeting Commentary

Updated July 20, 2022

It’s perhaps one of the most telegraphed interest rate moves by the ECB in its history. Very specific guidance from numerous central bank officials will see the first rate rise in 11 years. But questions still remain at what has historically been a quiet summer meeting. Consensus expects a quarter point move while markets are pricing in around a 25% chance of a bigger 50bp hike. Aside from the size of the rate hike, focus will be on the ECB’s guidance for September and its “anti-fragmentation” tool which is aimed at limiting sovereign spread divergence and improving monetary policy transmission. 

Now that QE has finished, the ECB’s core mechanism to fight record eurozone inflation and return it to the bank’s target over the medium term is the policy rate. It seems that there is broad agreement among both hawks and doves that the ECB will hike by 25bps at this meeting. Governing Council members have strongly guided for that size of rate rise, while the economy and growth outlook have weakened sharply in recent weeks. This would appear to close the door to a bigger hike similar to other central banks, especially due to the current volatile Italian political situation and the gas crisis.  

In this environment, President Lagarde seems likely to repeat the message from the ECB’s prior meeting regarding the September policy decision. This means that if the inflation picture doesn’t improve, the depo rate will likely be raised by an even larger increment of 50bps. We note that the market has priced in around 90bp of tightening across this week and the September meeting, so there is a material risk for a euro selloff if expectations are not realised.

Further details around the anti-fragmentation tool will be closely watched as lifting rates exposes the bond yields of the region’s peripheral countries to higher spreads. Can the ECB come up with a “bazooka” that the market considers credible? This programme will need to be big, flexible and without limits to satisfy all participants, thereby minimising interventions and avoiding one-way bets. Interestingly, the gap between Italian and German benchmark 10-year bond yields widened to the most in a month recently. This indicates that investors are demanding a higher premium to hold riskers eurozone debt and is a warning sign to policymakers. 

One final question is whether the ECB addresses the woes of the euro as it flirts below parity to the dollar. The current pre-commitment of rate hikes is like bringing a knife to a gunfight given rampant inflation and a Fed moving by at least another 75bp at the end of this month. Recession fears as global growth wanes, and the prospect of EU energy rationing has seen the region’s trade balance implode to its worst deficit since the euro’s inception. The backdrop for the single currency does not look promising. That said, don’t forget that the ECB has actually surprised to the hawkish side at every single meeting in 2022. 

Written by Jamie Dutta, Market Analyst for Vantage

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