The ECB has opted to bring forward the withdrawal of its debt purchase programme (APP) and has opened the door to a rise in interest rates in the face of persistent inflation. Specifically, the pace of net purchases under the APP programme will be reduced to 20 billion euros in June. The institution chaired by Christine Lagarde has updated its forecasts, lowering its GDP growth forecast for 2022 by half a percentage point to 3.7% and raising the inflation outlook by almost 2%, due to the war in Ukraine.
The European Central Bank is ready to raise rates if necessary because of the risk of stagflation. Lagarde could end stimulus in June, opening up the possibility of a rate hike before the December meeting. Here are the first reactions from international fund managers after the ECB meeting.
Martin Wolburg, Senior Economist, Generali Investments Partners
At yesterday’s meeting the Governing Council (GC) surprised again on the hawkish side. The unwinding of QE will be accelerated, and asset purchases will end by June unless the inflation outlook deteriorates. Pandemic-related asset purchases will end by March, as expected.
But at the same time the GC emphasized uncertainty and data-dependency regarding future policy action. It basically eliminated the time-link between the end of net asset purchases and the first rate hike while maintaining the sequence of policy steps.
The updated staff projections back the case for policy normalization. Unless downside risks to the medium inflation outlook materialise, we see the way paved for the start of the normalization cycle in 2022. The ECB’s proprietary baseline case seeing growth at 3.7% in 2022 would be consistent with two rate hikes this year.
We are more cautious regarding the fallout from the war and see the euro area growing by only 2.2% in 2022, well below the ECB’s expectation. We therefore continue to see only one hike in December but acknowledge that the risk shifted again towards two hikes this year.
Reto Cueni, Chief Economist, Vontobel
The ECB reiterated to stop its Pandemic emergency purchase program (PEPP) at the end of March but said to increase the pace of the reduction of its asset purchases under the traditional Asset Purchase Program (APP). After June, the ECB said to stop its net asset purchases if incoming data on inflation and growth support the medium-term outlook for inflation and matches with the ECB target of 2% inflation, otherwise the ECB can also increase again purchases.
The ECB changed its forward-guidance from adjusting key rates “shortly after” to “sometime after” the end of the net purchases under the APP. The ECB made no changes to their long-term financing rules for banks under the TLTRO program and seems to stop the very favorable conditions for banks in June.
The ECB now sees the risks to the economic growth outlook as tilted to the downside and to inflation to the upside, at least in the near-term, both due to the war between Ukraine and Russia. ECB reduced its GDP forecast for 2022 from 4.2 to 3.7%, but upgraded its inflation forecast from 3.2 up to 5.1% for 2022, from 1.8 to 2.1 in 2023 and kept it below 2% (at 1.9%) in 2024.
It seems that the fight between hawks and doves intensified after the outbreak of the war between Russia and the Ukraine, as the doves emphasized the downside risks to the growth outlook while the hawks stressed the increased inflationary pressures. The hawks seem to have successfully insisted on the intensified upside risks to inflation due to higher energy and food prices and a somewhat stronger feed through to core inflation. Lagarde stressed that wage growth still looks tame in the Eurozone but that some increase in wage pressure should be expected to come.
Overall, it seems that the ECB members dealt quite differently with the current inflation and that the ECB is still on track to normalize its policy but also wants (on average) wait and see how the conflict and its impact on the economy is evolving. President Lagarde tried to emphasize that this is not an overall acceleration of the “normalization” of the ECB’s monetary policy and the adjusted forward guidance would allow the Governing council to keep all its flexibility in further adjustments of the key rates. However, that was an odd argumentation as the hawkish tilt on the end of net asset purchases was described very clearly in the policy statement.
Peter Goves, Fixed income analyst at MFS Investment Management
Despite acknowledging the uncertainty stemming from the Ukraine conflict, the ECB policy decision had a hawkish tilt. Indeed, the ECB chose to wind down the APP schedule more quickly than the December guidance and revised its rate guidance. The ECB also tweaked its guidance and removed a previous dovish bias which referenced the prospect of rates remaining at present or lower levels.
The market quickly reassessed the rate path to increase hike expectations in H2. Lagarde made clear the sequencing remains intact and that there may be a lag between ending QE and the first hike, but the market still moved as if a hike would follow very soon after APP ends. Indeed, a 10bp hike is priced in Q3. The acceleration of the QE taper also saw periphery spreads widen. Despite some dovish language and stresses of “flexibility”, ultimately, the policy actions themselves are what matter.
HICP risks lie to the upside in the near term too which will continue to make for an awkward situation for policy makers. Overall, there is still a concern about the growth outlook and how high cost push inflation may weigh on demand. As such, upcoming sentiment and confidence indicators hold significance to assess the market outlook and its assessment on future ECB policy.
Axel Botte, Global Strategist Ostrum AM (affiliate de Natixis IM)
The ECB surprised with a more hawkish stance of policy. The ECB appears willing to accelerate tapering on the back of upside risks to inflation. Forecasts for inflation have been raised to 5.1% this year with 2024 projections consistent with price stability at 1.9%.
Our take on President Lagarde’s communication is that QE will be unwound within 3 months (by June) and the markets have been penciling in two hikes. That’s our first read. However, Lagarde again stressed optionality and the ECB will put forward two alternative (adverse and severe) scenarios gauging the possible impact of the war in Ukraine. In our opinion, the more adverse outcome would spell a more accommodative stance so that today’s hawkishness has some downside risks. The ECB may also need time to assess the expected impact of EU spending on energy diversification and defense. The ECB will welcome the issuance of joint debt as EU bonds become a natural benchmark for Euro fixed income markets over time.
Konstantin Veit, Portfolio Manager at PIMCO
As expected, today’s ECB meeting was focused on regaining policy optionality and flexibility, in light of extreme macroeconomic uncertainty. On the hawkish side, the ECB aims for a somewhat faster end of net asset purchases and dropped the reference to lower policy rates from its forward guidance on interest rates.
On the dovish side, the ECB suggested that the policy rate lift-off could possibly take more time after the end of net asset purchases, if warranted, and any rates cycle would be gradual. ECB monetary policy normalization might bend but probably doesn’t break, unless Europe falls into recession.
Over the medium term, the ECB will aim for ending net asset purchases and getting back to a zero policy rate, with little ambition beyond that.
Andrew Mulliner, Head of Global Aggregate Strategies at Janus Henderson Investors, EMEA
The announcement of a faster tapering of asset purchases by the ECB was a hawkish surprise to markets. Since the invasion of Ukraine, the smoke signals from Frankfurt indicated a wait and see approach given the significant uncertainty that the war presents to the European economy.
In addition to the decision to accelerate the pace of tapering, the ECB released staff forecasts that showed a sharp upward revision to the inflation forecast (albeit a forecast that still has inflation just below 2% in 2024) and downward revisions to growth. In terms of these forecasts the decisions to accelerate the tapering process could make some sense. However President Lagarde was at pains to highlight the uncertainty that the war in Ukraine presented and characterised the tapering change as an increase in optionality for the ECB in both directions; something that fails to pass the smell test in our opinion.
The somewhat confused nature of the communication of ‘huge’ uncertainty the need for optionality alongside an explicitly step towards less accommodation, speaks to a potentially a governing council caught between an instinct to do something about inflation far above target (even if the reasons are not something, they can do anything about) and an awareness that the potential supply shock caused by the war, could be materially negative for the European economy. To be unkind, there was a whiff of Trichet’s ‘there is only one needle in our compass’ in the actions today, a line that has become associated with central bank obstinance and ultimately policy error.
Lagarde’s style and background is to seek consensus rather than to drive a view. Her characterisation of herself as neither hawk nor dove, but owl is evidence of this. Whilst this is politically astute, arguably her press conference performance today suggests it has its limitations when trying to explain a monetary policy decision that suggests more conviction than the delivery would justify. It is perhaps too easy to suggest that the ECB under Mario Draghi would have had more confidence in either sitting on its hands citing uncertainty or accelerating taper because inflation required a response. But understanding precisely what the ECB were trying to achieve today, if not tighter monetary conditions, is a challenge.
Unsurprisingly, bond yields are higher and peripheral spreads are wider. This ECB seems to be for a reduction of accommodative policy at all costs.
Silvia Dall’Angelo, Senior Economist, Federated Hermes – Reacting to today’s ECB meeting
Despite the fact the ECB was never expected to announce a big policy shift, today’s meeting was set to be one of the most difficult in some time, due to the stagflationary impact that the war in Ukraine has imparted on the European economic outlook.
The ECB sounded hawkish on balance, suggesting inflationary concerns have intensified since the last meeting, mainly reflecting a cost-push shock from higher energy prices, but also some domestic developments, including ongoing tightening of the labour market, with the unemployment rate now running at a record low of 6.8% in the Eurozone’s history. Crucially, updated forecasts showed a significant upgrade to the inflation outlook, with core inflation at 1.9%, close to target, in 2024, the end of the forecasting horizon. At the same time, while growth projections were revised down significantly, they continued to show a continuation of the recovery over the forecast horizon.
Overall, the ECB has maintained its gradual trajectory towards policy normalisation, focusing at this stage on the improving domestic inflationary picture. In the ECB’s base case, APP net purchases end in Q3 of this year, paving the way to lift off in Q4. However, the war in Ukraine has injected a great deal of uncertainty around the ECB’s base case – to the point the central bank’s staff have produced forecasts for an alternative scenario alongside the main one.
Accordingly, President Lagarde stressed optionality, flexibility, and data dependency, as the ECB navigates an uncertain and fast-evolving economic and geopolitical landscape dominated by deteriorating growth-inflation trade-offs. At a minimum, war-related uncertainty will ensure the ECB proceeds cautiously and gradually. In the worst-case scenario, it is possible the ECB will have to resort to a new emergency package of measures and delay lift off, although it looks like the fiscal levers available at both the EU and national levels will have to do the heavy lifting in response to negative and possibly worsening consequences of the war in Ukraine.