The ECB meeting took place yesterday. Not many changes since last meeting, talks of inflation driven by shortages and higher energy prices, sustainable recovery on the way, but growth conditions are not yet back to pre-Covid levels since euro area growth is expected to stay below trend through 2022, however, Christine Lagarde made it clear that there is not risk of Stagflation. We have received the first commentaries and thoughts from economists on the outcomes of the ECB meeting.
Samy Chaar, Chief Economist at Lombard Odier
With the ECB facing the risk of upside surprises in incoming headline inflation, driven by shortages and higher energy prices as demand recovers, market expectations for the ECB’s outlook aggressively repriced with a 20 basis points ‘lift-off’ hike by the end of 2022. This has forced the European Central Bank to reassess its policy stance at today’s meeting.
As expected, the ECB’s statement is little changed since early September’s. The economic recovery remained strong over the summer (Q3 GDP will be released 29 October). With a sustainable economic recovery in place, the chances that PEPP ends next March are extremely high. However, longer term, growth conditions are not yet back to pre-Covid levels since euro area growth is expected to stay below trend through 2022; this reinforces the assessment that market’s expectations of a hike in 2022 are too aggressive.
On inflation, the statement repeated that the risks are to the upside. The central bank still argues that much of inflation’s rise remains transitory, although pressures may take longer to ease. For now, we see no signs of major wage acceleration on the back of 2021’s inflation, and inflation should fall below target in late 2022 and 2023.
The ECB President rejected recent market expectations of a first rate hike in 2022, stressing that conditions for a rate rise are unlikely to be in place that quickly. Also, she said that there will be no rate rise until inflation is projected to hit 2%, and stay there. Current ECB projections show inflation staying well below 2% until the end of 2023, reaching 1.6% in the fourth quarter of that year.
Overall, President Lagarde deferred any other changes until December’s outlook, when the ECB publishes its macro-economic projections through 2024. Typically, avoiding a cliff edge on TLTROs will be part of the December decision. Also, the run-up to the December meeting will be key in shaping the Council’s discussion on the reform of the asset purchase programme (APP) for the post-PEPP period). Several options exist: increase the PEPP to taper more gradually (but this seems unlikely considering Mrs Largarde’s comments); expand the APP to bridge the end of the PEPP; make the APP as flexible as the PEPP on issuer limit and capital keys. In December, the ECB could drop the word “shortly” from its commitment to end the APP “shortly before” raising rates. That would strengthen its forward guidance on rates, but we see no ECB rate hike before 2024 since inflation would have to overshoot the central bank’s 2% target to counterbalance periods of inflation below its target.
Reto Cueni, Chief economist at Vontobel
President Lagarde said according to her view, the PEPP should finally stop at the end of Q1/’22 but did refrain from sending any message about how (time frame, amount) the current asset purchase programs would be adjusted further and referred to the next meeting in December (16th).
She made clear that the Governing Council (GC) wants “to avoid a cliff edge [on TLTROs]” and that this will be part of the discussion in the December meeting.
Lagarde emphasized that she sees the current market pricing of future rate hikes to be disconnected from the ECBs forward guidance (i.e., too early, too high) and “conditions for a rate hike are likely not to be met in the timeframe expected by markets.”
The GC’s forward guidance still reads: “…, the GC expect the ECB key 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 pr. horizon …”
Lagarde and the GC stick to the view that supply shortages and energy price increases, which pushed inflation higher, will remain transitory although stay for longer than earlier expected.
Lagarde mentioned an unpublished ECB company survey that seems to confirm prolonged supply shortages until Q1/’22 or even longer in some sectors, but that they will “gradually fade in the course of 2022”.
To judge about potential sings of a wage-price spiral, Lagarde said to carefully analyze the wage developments in the Eurozone, which could be “fueled by these shortages”. But she mentioned also the many people, who are still un- or underemployed or who remain in a short-time work scheme in the Eurozone.
Lagarde’s new introductory statement reads now “… the gradual return of the economy to full capacity will underpin a rise in wages over time.” instead of “… therefore wages are expected to grow only moderately.” as stated in the last meeting on 9. September.
Finally, Lagarde said that “we are not seeing a stagflation as we do not see a stagnation, we still have a strong recovery, and the shortages will cool down economic growth and channel it to the next year”
Martin Wolburg, Senior Economist at Generali Investments
At today’s meeting, as expected the Governing Council (GC) did not change its policy stance. The key message is that the ECB continues to stick to its view of only transitorily higher inflation. But it acknowledges that its abating is taking longer than previously thought.
President Lagarde made very clear that markets have gone too far with rate hike expectations. The conditions for higher policy rates were not met at present and “certainly not in the near future”.
Markets slightly increased their rate bets defying Lagarde’s comments on market pricing. The ECB’s patience on inflation stands in clear contrast to other central banks.
Looking ahead, the December 16 meeting will be pivotal. With new macro projections PEPP purchases for Q1/2022 will need to be recalibrated and the GC will have to decide about the post-PEPP QE.
We look for € 40 bn/month (broadly in line with consensus) but see the risk that a deteriorating growth-inflation mix triggers a less benign stance.
Jon Day, Fixed Income Portfolio Manager at Newton Investment Management, part of BNY Mellon Investment Management
The ECB attempted to push back market expectations at their meeting yesterday but they are still firmly of the view inflation is transitory and will be falling back towards target next year, but even the ECB admitted inflation will be around for longer than they expected.
Europe is bearing the brunt of the rise in energy prices and with lack of supply, tightening environmental rules and the winter still ahead, it’s difficult to see the situation imminently resolving itself, inflationary pressures will be around for a while yet. The ECB are determined they will look through this inflation, but the market remains to be convinced, bonds sold off and the euro rallied post the meeting.
Eurozone yields remain very low by global standards reflecting the ECB’s ultra-loose monetary policy, they still remain poor value versus markets that are pricing in rate normalisation.
Silvia Dall’Angelo, Senior Economist, at the international business of Federated Hermes
It has been a big week for central banks, with monetary policy meetings across a variety of jurisdictions. They all underscored the challenges central banks are facing, as inflation is running high, while growth is faltering, amid persistent supply disruptions and new downside risks (i.e. an energy crisis in Europe and China, turmoil in the Chinese property sector, rising geopolitical uncertainty). While challenges are similar across the board, specific trade-offs are different and, accordingly, monetary policy paths have been increasingly diverging.
The most pronounced divergence has been between advanced economies and emerging markets. Several central banks in emerging countries – notably in Latin America – have already started to tighten their policies in response to elevated inflation. This week, the Brazilian central bank has hiked its policy rate for the sixth consecutive time, by a large 150bp clip to 7.75% (its highest level since October 2017), and hinted at another 150bp hike in December. Brazilian inflation is now running in double-digit territory, and risks becoming entrenched via the expectations channel. In addition, the central bank is trying to preserve credibility, while the government has embarked on a pre-electoral burst of fiscal giveaways.
Central banks in developed economies have generally adopted a more cautious approach to the withdrawal of the emergency stimulus measures thar were introduced at the beginning of the Covid crisis. Yet, as different countries are at different stages of the recovery, the signals on the evolution of monetary policy have been mixed. This week, the Bank of Canada adopted a hawkish tone, suggesting lift-off might take place as early as April of next year. By contrast, the European Central Bank and the Bank of Japan stuck to their guns for the time being, as their facing earlier stages of the recovery and more contained underlying inflationary pressures. In particular, the BOJ is facing a delayed recovery and stubborn deflation, hence there was no need to adjust accommodative policies.
At yesterday’s meeting, ECB President Lagarde pulled her usual balancing act, mixing hawkish and dovish elements in her narrative. On the one hand, she expressed conviction that the Pandemic Emergency Purchasing Programme (PEPP) will end at the end of March 2022, in what sounded like almost a pre-commitment. On the other hand, she reiterated that internal careful analysis suggests elevated inflation will likely be temporary. Importantly, she pushed back against market expectations pricing in an ECB rate hike in 2022, albeit somewhat softly. Overall, Lagarde gracefully maintained the ECB’s policy course ahead of the highly anticipated December meeting. At that point, the ECB is expected to provide clarity about the future of its asset purchase programmes – most likely, the APP programme will be reinforced in terms of both size (currently €20bn per month) and conditions (retaining the PEPP’s flexibility). Indeed, an accommodative policy setting still seems appropriate to achieve the 2% inflation target over the medium term, as underlying inflationary pressures still look muted. In addition, the ECB has tended to overact to high inflation in the past (e.g. by raising rates in 2008 and 2011, just before recessions hit) and is therefore wary of repeating the mistakes of the past.
Next week all eyes will be on the Fed and the Bank of England. The Fed is likely to start tapering, based on substantial progress towards both its inflation and employment goals since December of last year. Meanwhile, the Bank of England could become the first major DM central bank engaging in lift-off, as it signalled it could raise rates by the end of the year (most likely a 15bps hike to 0.25%).
Peter Allen Goves, Fixed Income Analyst at MFS Investment Management
Policy was left unchanged at today’s meeting, as widely expected, yet despite rising inflation. This is because of the ECB’s stress that the current rise in inflation is likely to be transitory. Growth is still considered strong but is moderating and risks are broadly balanced.
This meeting was perhaps characterized by its emphasis on inflation drivers. Importantly, the ECB continues to stress that many of the current drivers for rising spot inflation are largely transitory. Lagarde elaborated on base effects, bottlenecks and energy prices to support this view. All things equal, this should see inflation move back to target in 2022, even if it might now take a little longer than first envisaged.
Perhaps the most interesting takeaway from the October ECB is the interplay between the ECB’s guidance and its inflation outlook compared with market policy rate expectations. Lagarde referred to a disconnect, which in our view, is unlikely to last forever. Either the ECB hikes in line with market expectations or it doesn’t. In terms of QE policy evolution, we continue to look at the December meeting as a more pivotal juncture for asset purchase developments. For now, policy remains steady.