Markets
The ECB lift its key policy rates by 25 bps today with the key deposit rate now at 3.25%. That’s a downshift from the previous 50 bps pace which we expected to be continued, but in line with market expectations. The decision wasn’t unanimous, but the 50 bps pace was the minority call. The press statement starts with the notion that the inflation outlook continues to be too high for too long with recent data broadly confirming the inflation outlook as set out in March. Especially underlying price pressures remain strong and risks to the inflation outlook remain tilted to the upside. The final sentence of the statement dropped a first hint as to why the ECB slowed its tightening pace: “the past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of the transmission to the real economy remain uncertain.” A second one came during ECB Lagarde’s press conference where she made clear that the Bank Lending Survey published earlier this week was decisive for reducing the tightening pace to 25 bps. Loan growth for firms and households weakened owing to higher borrowing rates, tighter credit supply and lower demand. The ECB’s tightening cycle isn’t over though with the central bank continuing to follow a data-dependent approach and vowing to bring policy rates to sufficiently restrictive levels in future decisions (plural, emphasis added; Lagarde namedropped the June, July & September meetings) to achieve a timely return of inflation to the 2% target. As Lagarde said: “it’s clear that the ECB isn’t pausing and that we have more ground to cover”. There’s no magic (policy rate) number for a sufficiently restrictive policy, but we’re not there yet. Perhaps somewhat as a (minor) quid pro quo – though denied by Lagarde – the ECB announced that it expects to discontinue the reinvestments under the APP all together as of July. That compares to the current €15bn/month pace during Q2 and was suggested by the likes of ECB Wunsch and others over the past two weeks. Over the next 12 months, this new APP reinvestment stance suggests that an additional €160bn of liquidity will pulled from the market. These amounts will gain traction in coming years given the way the €3200bn APP portfolio was built mainly during 2016-2018 (average maturity of APP portfolio rapidly declining). Lagarde confirmed that the end goal was an empty APP portfolio in 15 years’ time, but the ECB keeps some optionality in the process. European yields initially dropped at the front end of the curve with markets interpreting the dovish hike as bringing us to a 3.5% terminal rate already by June. The front end recovered somewhat during the press conference as Lagarde stressed that the journey isn’t over yet. Longer bond yields immediately started rising on a combination of ending APP reinvestments, but also on rising inflation expectations. Changes on the German yield curve vary between -5.1 bps (2-yr) and +7.2 bps (30-yr). EUR/USD in a same way fell from 1.1080 to 1.10 before rebounding back to 1.1040. The EuroStoxx50 erased some of the intraday losses on the ECB call to currently lose around 0.5%.
News & Views
The Norwegian central bank raised its policy rate by 25 bps to 3.25% today. In evaluating its March projections it concluded that: inflation (6.5%) was higher than expected, economic activity – private consumption in particular – stronger, the labour market tighter, wage growth faster and the Norwegian krone (much) weaker. The latter just yesterday set a new record low at EUR/NOK 11.89, excluding the illiquid period shortly after the pandemic outbreak. All of the above arguments argue for a higher terminal rate. Yet, the Norges Bank stuck to the March guidance projecting a 3.5% peak policy rate by June. Governor Ida Wolden Bache did finish the policy statement saying that “If the krone remains weaker than projected or pressures in the economy persist, a higher policy rate than envisaged earlier may be needed.” But it is possible that Oslo is looking for new economic forecasts (due in June) to underpin such a higher rate path. With the benefit of the doubt, the Norwegian krone slightly appreciates today to EUR/NOK 10.83. Norwegian swap yields eke out a few bps across the curve.
French Finance Minister Le Maire together with Bank de France and ECB governor Villeroy will discuss potential adjustments to mortgage rules on Friday to ease credit distribution in the country, Agence France-Presse reported citing Le Maire. The two are expected to discuss the so-called usury rate; the maximum rate at which French banks can lend. This cap is being reviewed every month until July instead of every quarter, an exceptionality that authorities may extend. Lending rules that state that banks cannot distribute loans if repayments exceed 35% of borrower’s income are also subject for discussion in a bid to create more lender flexibility.
