ECB signals March re-assessment

ECB View: No fight back on rate hike pricing as officials get spooked by inflation

The ECB left its forward guidance on policy interest rates and asset purchases unchanged in its policy statement. However, clearly the ECB is not in the mindset that it was in a few weeks ago. President Christine Lagarde noted that ‘the situation has changed’ with regards to the outlook, noting upside risks to the December inflation projections, especially in terms of the near term. She signalled that the guidance was contingent and that the Governing Council would be flexible and data dependent. Unlike in December, Ms Lagarde did not take the opportunity to steer markets away from a 2022 rate hike, saying that she would reserve her judgement until the institution’s March updated macroeconomic projections. Although the ECB President confirmed the sequencing of the exit (net asset purchases need to end before policy rates go up), she did suggest that the path of net asset purchases under the APP could be changed if necessary.

Overall, the press conference gave the impression of a central bank that is gearing up to unwind net asset purchases and start raising its policy rate before the end of this year. This is in sharp contrast to our base case, which sees policy rates on hold during our forecasting horizon. Although the chances of a rate hike this year have clearly gone up significantly, we are not changing our base case for now. First, we will assess incoming communication from other ECB officials, especially Chief Economist Philip Lane, who is responsible for the staff macro projections. Second, Ms. Lagarde might be underplaying the growth impact of surging energy prices. Real wages are falling sharply and this will likely hurt consumer demand. So although higher headline inflation could also feed through to higher medium term outcomes, the negative impact on growth will likely at least offset that effect. More generally, it is difficult for us to see the case to raise interest rates in the face of a supply-side shock when we are seeing few signs of second round effects. Indeed the growth of negotiated wages in the eurozone remains very subdued, with the annual growth in this series at a record low. We will be re-assessing our ECB scenario based on the incoming information. (Nick Kounis & Aline Schuiling)

BoE View: 25bp hike, with guidance that more is in the pipeline

The Bank of England raised its policy rate by 25bp today, in line with our and consensus expectations. The central bank’s communication about the decision provided mixed messages. On the one hand, four MPC members voted for a larger 50bp hike, and it is clear that further moves are likely in the coming months. On the other hand, the BoE is forecasting quite a slowdown in economic growth, a rise in unemployment, and an eventual undershoot of its inflation goal towards the end of its horizon. Indeed, the BoE notes that ‘conditioned on the rising market implied path for Bank Rate (1.5% by mid-2023 at the time of the projection) and the MPC’s current forecasting convention for future energy prices, CPI inflation is projected to fall back to a little above the 2% target in two years’ time and to below the target by a greater margin in three years’. In addition ‘in an alternative scenario that is conditioned on energy prices following forward curves throughout the forecast period …CPI inflation is around ¾ percentage point below the 2% target in two and three years’ time’. We think that this trajectory is in line with our base case for the BoE. All told, we continue to expect additional 25bp hikes in May and in August, but a more gradual tightening of policy thereafter. Put another way, we think financial market pricing looks too aggressive given the overall macro picture in the UK. See our note here for more. (Bill Diviney & Nick Kounis