The ECB is meeting this week after the decisions taken just last month to reduce the pace of net purchases, it is believed that the ECB might refrain from making any policy changes on this week’s meeting. The invasion of Ukraine by Russia, and the sanctions imposed to Russia have created a climate of uncertainty and put the European Central Bank on a difficult position.
Prior to the meeting, we have received the first commentaries from the professionals in the asset management industry.
Pietro Baffico, European Economist, abrdn
The ECB is caught between a rock and a hard place. It needs to balance rising inflation with the downside risks to growth, while economic uncertainties remain high, fuelled by the brutal Russian invasion of Ukraine and by EU sanctions.
Given the decisions taken just last month to reduce the pace of net purchases, the ECB might refrain from making any policy changes on April 14th, and wait to revise its stance in June. However, following the higher than expected inflation at 7.5% in March, President Lagarde will likely keep hawkish tones, stressing optionality going forward, and potentially signalling future revisions of net purchases, possibly to end before September to widen the window for a first rate hike.
Investors should brace for more volatility in the coming months, with further adjustments of policies and pricing in either direction. At the short end of the curves, June and July ECB meetings could be repriced lower if the ECB confirms net purchases in the third quarter, as policymakers might still try to look through the high inflation driven by energy.
Thomas Hempell, Head of Macro and Market Analysis at Generali Investments Partners
The proximity of the euro area to Russia and the Ukraine contributes to a stark fall-out on sentiment and activity. The primary channel is the the region’s high depend-ence from Russian gas imports. It accounted in 2020 for about 45% of all gas imports for the EU. Among countries, Germany and Italy are particularly exposed, making both countries especially vulnerable to the fallout from potential supply disruptions and sharply rising gas prices.
Euro area inflation rates north of 6% yoy over the months to come will be a drag on purchasing power and consumption. March saw already a sharp fall in consumer con-fidence heralding a strong blow to growth. Moreover, while manufactures are advanc-ing in repairing supply chain disrupted over the pandemic, the Russian invasion cre-ates new disturbances. Hence, while only slightly below 3% of all goods exports go to Russia, we look for a strong deceleration of activity over the summer half. Forward-looking components in key sentiment indicators weakened considerably as of late. However, there are still pandemic-related excess savings to be deployed and fiscal support measures of about 1 ½%. in 2022 and ½ % in 2023 mitigating the fallout. All in all, we expect activity to come to halt over the summer half and even see the risk of a technical recession. Output is set to grow by 2.2% and 1.6% in 2022/23, but this year’s growth will be largely technically driven by a statistical overhang from H2 2021.
The Russian war against Ukraine has pushed the ECB further in a dilemma. On the one hand sky-rocketing energy and commodity prices add to already elevated inflation pressure which will persist. Import, producer and commodity prices as well as busi-ness surveys all indicate unabated inflation pressure. And with the labour market in good shape, we see the potential for significantly rising wages. On the other hand, the looming sharp slowdown warrants rather policy easing than tightening. Financing conditions also deteriorated due to the more aggressive stance by the Fed.
In this dilemma we expect the ECB to proceed with caution. It will likely end its QE purchases in Q3 but only act in December (by a 25 bps hike) when activity should improve again and the expectation of higher wages materializes. Thereafter we look for ongoing measured policy normalization. The risks are clearly tilted towards an earlier first hike, e.g. due to the de-anchoring of inflation expectations. Conversely, the hurdles for not acting or even extending QE are high. It would in our view need a deep recession to prevent the ECB from reacting to the substantially changed inflation environment.
Konstantin Veit, Portfolio Manager at PIMCO
Headline inflation surprised meaningfully to the upside again in March, which makes a further upward revision of the ECB’s inflation projections in June all but certain.
With the ECB more concerned with the inflation outlook than growth, we believe it will continue the process of policy normalisation, with targeted fiscal policies in charge of supporting private demand unless the economic situation deteriorates markedly.
We do not believe the ECB will take significant monetary policy decisions at the April meeting, but its macroeconomic staff projections in June will likely provide the ECB cover to end net asset purchases in July, with a first 25bps interest rate hike in September a plausible scenario.
While the ECB will aim for a non-disruptive normalisation of monetary policy, risks to the macroeconomic outlook and central bank communication challenges remain elevated.
Annalisa Piazza, Fixed-Income Research Analyst, MFS Investment Management
In our view, this month’s ECB meeting is unlikely to end with any firm policy change. However, signals of some policy normalisation will be confirmed as the ECB is becoming more and more concerned about current inflation dynamics.
Despite increasing risks stemming from the Ukraine/Russia conflict (both via higher energy prices and additional supply constraints), couple with the sharp fall in consumer confidence, the ECB will continue to argue the inflation picture justifies the start of policy normalisation. We rule out the ECB will set a date for the end of the Asset Purchase Programme this week as the uncertainties around the economic picture remain blurred. Having said that, Lagarde will make clear that Q3 is the baseline scenario with some leeway to change depending on the economic developments. Signs of underlying inflationary pressure building up would move risks towards an earlier exit.
We anticipate the ECB to start its gradual hiking cycle in the last quarter of this year as the Governing Council is willing to adjust rates back in slight positive territory before another recession strikes. However, risks of market fragmentation complicate the overall situation as the GC is concerned higher yields might undermine a smooth transmission across all the Economic and Monetary Union economies. Talks about a tool to reduce fragmentation is back on the table (also because some smaller semi-core economies are currently badly hit) but we suspect no agreement nor official announcement this week.
The ECB communication will remain challenging as the Governing Council is in front of higher inflation numbers to what could be possibly expected, tighter financial conditions, falling confidence on the prolonged Ukraine conflict and the impact of higher prices on disposable income.Periphery/core spreads have been widening a touch in the past week or so, but they are relatively well behaved, especially if we consider PEPP is over and some have seen the latter as being the major reason behind tighter spreads. Liquidity conditions are challenging for some small semi-core sovereigns and the ECB will need to address risks of intensifying sovereign systemic stress across all the area.
Overall, we expect the ECB to make clear that flexibility will be used to avoid fragmentation and the effort could go beyond the use of PEPP reinvestments accordingly. Talks about a new facility the ECB could be studying to be used in case of a deep market fragmentation have circulated over the past week or so. We welcome further initiatives from the ECB to reduce fragmentation but some volatility near term cannot be ruled out.
Erick Muller, Director – Product and Investment Strategy & Ian Horn, Portfolio Manager Muzinich&Co
The surge in March eurozone inflation data was another upside surprise and shows how broad-based the price increase was with core inflation also seeing a significant jump. This data may be followed by another uncomfortable April print as some of the oil price increase may not have been fully captured in March. This supports the European Central Bank’s (ECB) pivot visible at the January meeting which has been since re-confirmed.
We do not expect any specific decision on interest rates or another change in the asset purchase programme calendar; we continue to expect it to end in July. However, we expect the narrative of this week’s press conference should show that a lift off in rates by the beginning of the fourth quarter 2022 is a real option for the governing council, should inflation not decline as expected this summer.
The fact that the Federal Reserve is preparing markets for an acceleration of interest rate tightening and for an early start of the run-off of its balance sheet may create some pressure on the ECB to be more explicit on this “optionality” to raise rates before year ends, even if the ECB has always pushed back on this type of comment. However, we notice that the euro has steadily weakened versus the US dollar since mid-February, and that is not a welcome development when energy and international food prices are rising.
Andy Burgess, fixed income investment specialist, Insight Investment at, BNY Mellon IM
With the Federal Reserve now expected to announce the start of its balance sheet reduction programme in May, all eyes are on the European Central Bank (ECB) meeting this week as investors seek to pin down a date for the conclusion of its bond purchase programme.
ECB President Lagarde has previously stated that interest rate hikes would only occur after quantitative easing (QE) had ended – an earlier date for the final month of QE, say June or July, could hint at a faster normalisation of interest rates later in the year. However, although elevated inflationary pressures will clearly be a focus for the ECB, the uncertainty stemming from the conflict in Ukraine is almost certain to be noted. We believe this will be sufficient to push the first hike into Q4, giving the central bank more time to make a judgement on the evolving growth outlook. The main risks to this view are that they move sooner rather than later.
Gilles Seurat, Fixed Income and Cross Asset Fund Manager, La Française AM
The European Central Bank (ECB) Governing Council meets this week. There will be no update to their macroeconomic forecasts but stay tuned: soaring inflation has changed the political pressure from a relaxed stance to fighting inflation. Previous commitments are no longer deemed valid.
Our expectations:
Rates should remain unchanged for the time being and the Governing Council should keep the sequencing: by first ending the Asset Purchase Programme (APP) and then by hiking rates.
Sources said that during the previous meeting the board was divided, with 10 hawks calling for immediate action and 15 doves voting for status quo. The 5-year breakeven inflation rate in 5 years’ time has risen by 27bps since March 10 to 2.36%, above the ECB’s target rate. Therefore, we could witness more hawkish pressure this time.
The APP is set to reach EUR20bn for the month of June. The Governing Council should provide some insight about its pace in the following months. Given that inflation is so high – and should stay around current levels until September, the ECB could announce that it intends to end purchases at the end of June. This would open the possibility of a rate hike as early as in July. September is however a more credible option. Governor Makhlouf said that the ECB wanted to “maintain optionality” so the governing council might want to keep all options open.
Overall, a hawkish ECB is a real possibility. Inflationary pressures are very strong, and the labor market is extremely tight, with the unemployment rate at an all-time low. The missing piece remains wages, for which recent data is unfortunately missing.
Franck Dixmier, Global CIO Fixed Income at AllianzGI
The European Central Bank (ECB) is under pressure. In March, it took a step towards normalising its accommodative policy by accelerating the pace of the reduction of its asset-purchase programme, but without opening the door to a rate hike in the third quarter. Since then, the conditions have changed:
- Inflation continues to rise and surprise on the upside. With an annual rate of 7.5% in March compared to 5.9% in February and 6.7% expected, inflation is now at an all-time high and sits at almost four times the ECB’s target.*
- Inflation expectations have started to drift upwards, with 5-year/5-year swap inflation (a measurement of “medium-term to medium-term” inflation) at 2.3%, compared with 1.9% at the beginning of the year.* The 5y/5y rate is also above the ECB’s medium-term objective of 2%. While there is no price-wage loop currently at work in the euro zone, with wage increases remaining contained, the risk of a shift in expectations and second-round effects has increased.
- The international context is one of tightening monetary policies. In particular, the US Federal Reserve (Fed) has announced that it is very determined to raise rates quickly and sharply, and that it is ready to rapidly reduce the size of its balance sheet.
- Finally, the uncertain economic and financial context – made more volatile by the invasion of Ukraine by Russian armed forces – is resulting in an additional inflation shock, particularly on energy and food prices.
In these conditions, it seems difficult for the ECB to justify its very accommodative monetary policy. At the next meeting, it should therefore announce – as the Fed has done loudly – a return to the fundamentals of its mandate, which is to ensure price stability. Whatever the profile of inflation in the coming months, and even if a deceleration is most likely (as stressed recently by several Board members), it is inconceivable for the central bank to remain passive in the face of current price levels. Especially since financial stability – which is often referred to as the ECB’s secondary mandate – does not seem to be at risk at this stage, given the levels of spreads and manufacturing indices (eg, the purchasing managers’ index, or PMI).
The minutes of the ECB Governing Council meeting of 10 March confirmed that this issue is increasingly present in the discussions. The divergence between its members has widened, but the balance of power is increasingly in favour of rapid tightening. Only the uncertainty over the conflict in Ukraine remains a brake on more forthright and rapid action.
We believe that the ECB should therefore confirm the end of the asset purchase programme (APP) for the third quarter, and perhaps even announce a specific end date. The ECB is also expected to reiterate its willingness to raise rates following the end of asset purchases. Markets are expecting two 25-basis-point hikes before the end of this year. The ECB is not expected to announce a timetable for these hikes, but it could indicate its willingness to do more if inflation is stronger and more persistent than expected, which would continue to fuel the upward correction in euro-zone rates.
