Despite inflation, the ECB will not raise interest rates

At their meeting today, the ECB has decided not to raise interest rates, despite the high level of inflation in the eurozone, and the fact that other central banks have begun monetary easing, and plan to carry out several rate hikes in the short term. This is in line with market consensus forecasts. The organisation presided over by Christine Lagarde is committed to helping the EU's economic recovery, which is still weak, and is still thinking about the transitory nature of inflation.

These have been the reactions from the professionals within the asset management industry about the decision made by the ECB. We had the insights from Fidelity, PIMCO, Nordea AM, BlackRock and BNY Mellon.

Anna Stupnytska, global macro economist at Fidelity International

While sticking to its dovish message for now, the ECB is the main central bank that has the potential to spring a hawkish surprise later in the year, as higher and stickier inflation will likely give hawks the upper hand. While we expect no rate hikes for 2022, we believe the ECB will start preparing markets for the first rate hike to come in 2023, potentially as soon as the March meeting, by laying the ground for ceasing asset purchases at the end of this year and revising its medium-term inflation forecasts to a target of 2%.

Konstantin Veit, Portfolio Manager at PIMCO

Next stop is March, where we will get new macroeconomic staff projections. If the already reasonably hawkish inflation projections feature material upward revisions for 2023 & 2024, the ECB will likely contemplate a somewhat accelerated exit path, a scenario the market is already pricing. The market is now fully pricing a first 10 basis points rate hike in July, which implies an end to net asset purchases as early as April.

If, on the other hand, medium term inflation comes down in line with or below current projections, the ECB will likely be on auto-pilot for most of the year.

Sebastien Galy, Senior Macro Strategist at Nordea Asset Management

But crucially, the ECB now flags March as the date when it can assess medium-term inflation dynamics, while it assesses inflation has having upside potential in the near term before moderating a few months hence.

To be more precise, the ECB statement on the 3rd of February stated that “The Governing Council expects the key ECB interest rates to remain at their present or lower levels until it sees inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at 2% over the medium term”.

There are actually some signs of sporadic labor shortages according to a December European Commission survey, but the broad story is still significant slack in the labor market led by hard hit leisure sector. Furthermore, wages are too low to attract back immigrants that had fled Covid-19 and younger but also sometimes older workers back into the labor pool. For example, the pool of unemployed experienced managers over 50 is over 100K in France.

What the ECB therefore needs for a long-period of economic inflation with moderate inflation is for wages to pick-up at a moderate pace. That suggests that in March the ECB will announce the end of the APP program and flag the first rate hikes next year, far later than the market expects. The odds are that over time, the ECB will continue its slow hawkish turn and catch-up with expectations in the Swap market. As a consequence of this, the euro is supported versus the dollar.”

Marilyn Watson Head of Global Fundamental Fixed Income Strategy at BlackRock

In addition, other factors impacting investor sentiment include geopolitical tensions, US earnings releases and activity restrictions in various countries aimed at stemming the latest wave of the COVID-19 virus.

Today, the Bank of England (BoE) raised key interest rates for the second time in a row, increasing its Bank Rate by 0.25% to 0.5%, as expected. All nine members voted for the hike, however, four members of the Monetary Policy Committee had pushed for a larger increase in the face of inflation running far above their 2% target. Furthermore, the BoE revealed that it will commence unwinding some of the assets that are currently on its balance sheet from its quantitative easing (QE) programme, by ceasing to reinvest maturing assets and begin selling down its corporate bond holdings.

Last week, the US Federal Reserve set the stage to commence raising its own interest rates soon, widely expected to be in March, and confirmed that QE purchases will end next month. Chair Powell acknowledged the tight labour market and that inflation is running well above the central bank’s target.

The European Central Bank (ECB) today also struck a more hawkish tone than in prior meetings, while keeping its current policy tools unchanged. Significantly, during the press conference, President Lagarde noted inflation is high and likely to remain elevated in the near term, taking their outlook for inflation over the medium term close to its 2% target. She also commented that GDP growth will remain subdued in the short term but should improve over the course of this year.

Lagarde reiterated that the ECB will stick to its previously outlined sequencing plan when adjusting its monetary policy stance, not hiking interest rates until it has completed its QE programme.  

As markets focus closely on large developed market monetary policy stances and investor sentiment around the globe shifts, economic activity data releases will be key.

In terms of positioning in our flagship global unconstrained bond fund, we remain short German duration and are long Spanish government bonds among other European positions. In foreign exchange, we retain tactical long positions in GBP and USD. We hold select exposures to emerging market bonds, including Mexico and Indonesia, and allocations globally to securitised assets, investment grade and high yield corporate bonds.

We are focused on the importance of bottom-up security selection in this environment, combined with a strong understanding of liquidity and risk management and an emphasis on stress testing and genuine portfolio diversification.

Paul Brain, Portfolio Manager, BNY Mellon Global Dynamic Bond Fund

The net effect is for the market to bring forward the timing of rates lifting off to the second half of this year. Without coming out with any clear details she suggested the markets pay attention to the next few meetings to determine when and by how much rates could rise and the balance sheet could shrink.

Earlier this week we saw the German Bund market 10-year yield rise above the 0% line for the first time since May 2019, prompted by the high inflation prints. With the ECB now starting the process of talking about raising rates, we would expect yields to continue to rise. Also, with less QE, the peripheral government-bond markets may come under pressure and spreads will rise.