Markets
The ECB hiked its policy rates by 75 bps: 0.75% for the deposit rate and 1.25% for the marginal lending rate. That makes a cumulative 125 bps tightening over just two meetings. All else equal, we expect another 75 bps move in October as part of the central bank’s frontloading efforts in transitioning away from the prevailing highly accommodative level of policy rates.
The central bank clearly commits to more rate hikes over the next several meetings to further dampen demand and guard against the risk of a persistent upward shift in inflation expectations. Data dependence and the meeting-by-meeting approach fit in the strategy of abolishing forward guidance when it comes to policy rates. Once bitten, twice shy after having to backtrack on its promise regarding both the timing and the size of the inaugural rate hike. The ECB sounds determined in battling what it labels as far too high inflation.
ECB staff once more upward revised quarterly inflation forecasts: 8.1% for 2022 (from 6.8% in June), 5.5% in 2023 (from 3.5%) and 2.3% in 2024 (from 2.1%). The central bank thus doesn’t envision a return towards the 2% inflation target over the policy horizon even if these forecasts imply a continuation of the tightening cycle. Risks remain primarily on the upside of the new outlook.
ECB President Lagarde at the Q&A session specifically mentioned euro weakness as adding to the ECB’s (inflation) woes. Underlying inflation is at elevated levels, but the wage dynamic remains contained overall. On the economic front, the central bank fears the EMU economy will stagnate later in the year and in Q1 2023. Very high energy prices bite into disposable incomes while supply bottlenecks still constrain economic activity. Consumer and business confidence is adversely affected. New GDP forecasts stand at 3.1% for this year (from 2.8% in June, thanks to better H1 performance), 0.9% in 2023 (from 2.1%) and 1.9% in 2024 (from 2.1%). Economic risks are clearly tilted to the downside of expectations.
The ECB keeps its reinvestment policy for maturing assets under APP (“for an extended period of time past the date when it started raising the key ECB interest rates”) and PEPP (“until at least the end of 2024”) unchanged. Last week, first rumours popped up that the central bank by the end of this year will also release a blueprint for quantitative tightening (ie balance sheet reduction). Finally, it’s worth mentioning that the two-tier system for the renumeration of excess reserves is no longer necessary following the raising of the deposit rate above zero.
Core bonds extended their sell-off during Lagarde’s press conference. The German yield curve bear flattens with yields rising by 8.5 bps (30-yr) to 14.6 bps (2-yr). European bonds clearly underperform US Treasuries which rise by 2.9 bps (30-yr) to 6.4 bps. The euro initially tried to make more headway above parity, but didn’t succeed. The sell-off in core bonds triggered a new downleg on stock markets (-1%) and peripheral spread widening (Italy 10y: + 8 bps). Lagarde’s clumsy mentioning that 75 bps rate hikes are not the norm even sparked a new euro sell-off with EUR/USD diving back below 0.9950. News Headlines
Hungarian inflation in August rose by a less-than-expected 1.8% m/m, slowing from 2.3% the month before. Price rose 15.6% on a yearly basis, increasing from 13.7% in July but missing forecasts of 15.9%. Core measures hit 19% y/y. Food prices surged more than 30.9%, explaining much of the price gains. Inflation will probably peak around 20% in the autumn following the rollback of household energy subsidies. It keeps pressure on the Hungarian central bank to keep tightening aggressively. Last month, it raised rates by 100 bps to 11.75%. Hungarian swap yields dropped more than 30 bps at the front end of the curve today. Money markets nevertheless still discount a terminal rate of 14%+. The Hungarian pared initial losses, trading around EUR/HUF 395, stable vs. yesterday’s close.
