This week sees the ECB’s first meeting of the year. After the last meeting in December, where President Christine Lagarde announced the end of the PEPP in March 2022, the industry expects a low-key meeting with no major changes to the roadmap.
Ahead of Thursday’s meeting, we have received the insights from the professionals within the asset management industry, with their thoughts of what to expect from the European Central Bank’s meeting from this week. We have received some commentaries from Generali Investments Partners, PIMCO, Jupiter AM and MFS Investment Management.
Martin Wolburg, Senior Economist, Generali Investments Partners
We think that the ECB will adopt to a step-by-step policy normalization course. It announced at the December meeting to end the PEPP after March 2022. It will thereafter temporarily increase APP purchases to smooth the scaling down of overall QE support to € 20 bn per month in Q4. Annual QE will likely come down to € 440 bn in 2022, from € 1080 bn in the last year.
Over the past year the GC stressed that the sequence for policy normalization is: (i) unwinding QE, (ii) hiking rates and finally (iii) selling (or not rolling over) purchased assets again (quantitative tightening). At the end of 2022 QE will have sufficiently come down so that stopping it should not lead to major market gyrations.
Given upside risks from energy prices, a likely stronger wage growth than currently pencilled-in by the GC and inflation expectations in line with target, we think that the ECB cannot afford to wait until 2024 and will need to act on rates in 2023 already. The hurdles for a rate hike under the new strategy are high: Both core and headline inflation need to be in line with the medium-term target well ahead before the end of the forecast horizon. But within the GC the awareness of heightened inflation risks seems to increase as the accounts for the December meeting reveal. Here, an increase in also underlying inflation was acknowledged, it was mentioned in the discussion that with the inclusion of owner-occupied housing costs inflation would have been higher and that there is a possibility of inflation being higher for longer. Moreover financial stability risks stemming from historically low rates could not be tackled by means of macroprudential measures only.
Over the course of the year the GC will likely need to adjust its projected inflation path (which will be done at the meetings in March, June, September and December) more and more to the upside so that the case for higher rates becomes stronger. In December 2022 the threshold for higher rates should be met. Moreover, the GC will also take into consideration that the latest stabilization of inflation expectations is largely due to the expectation of higher key rates. The ECB will have to deliver to avoid that inflation expectations rise further and become de-anchored.
All in all, we deem it now most likely that the ECB announces an end of QE for January or March 2023 and embarks on a first deposit rate hike by 20 bps in June 2023. The further policy moves will remain highly data dependent (especially on inflation) but we expect another hike in December 2023 (most likely by also 20 bps) which would leave the deposit rate still in negative territory (at -0.1%) but pave the way for an end of the negative interest rate policy persisting since 2014.
Konstantin Veit, Portfolio Manager at PIMCO
At the December meeting, the ECB formally announced the end of net purchases under the Pandemic Emergency Purchase Programme (PEPP) in March 2022.
They also communicated the asset purchase trajectory for the full year of 2022, comprising a gradual reduction in net purchases back towards the pre-pandemic configuration of open-ended €20 billion monthly purchases under the regular Asset Purchase Programme (APP) from Q4 2022 onwards.
As a result, the ECB will aim to make the February monetary policy meeting a low-key event, and we don’t expect any significant decisions coming out of this meeting.
In March, we will get new macroeconomic staff projections. If the already reasonably hawkish inflation projections feature material upward revisions for 2023 & 2024, the ECB will probably contemplate a somewhat accelerated exit path, a scenario the market is already pricing.
We believe the ECB will likely be on auto-pilot for most of 2022, as the bar for material additional easing beyond the pre-pandemic policy mix is high.
Talib Sheikh, Portfolio Manager at Jupiter AM
We look for the ECB meeting and subsequent press conference to stress ‘patience’ with no change to interest rate or balance sheet policy. In January we saw a dramatic repricing of global interest rates, most notably in the US as much of the “transitory” inflation narrative of the past 2 years has been ditched.
Risk assets have come under pressure since the December minutes revealed the Fed board had discussed quantitative tightening, (QT) debating an earlier unwinding of its $8.8 trillion balance sheet. Policy expectations in the EU have not been immune from this global repricing.
The European rates market looks for the process of normalisation to start with a single 25bp hike in 2022, followed by two hikes in 2023, taking rates into positive territory. We think this looks too aggressive.
That said, an inflation rate of 5%, well in excess of the 2% target, creates pressures on the ECB. We think the ECB will continue to resist the pressure to move in 2022. Long term inflation expectations are still under 2%, and therefore the ECB will want to be patient.
This view is not without risk: current inflation has been driven by supply bottle necks, COVID driven labour shortage and energy prices. We see tentative signs that these issues are easing. The key question is: can the inflationary dynamic in the goods side of the economy move into the services side, most notably with labour gaining real pricing power? At the moment, Europe isn’t seeing the wage pressures we are seeing on the other side of the Atlantic. While uncertainty around that view has risen, we think it is unlikely that inflationary labour dynamics will be sustained and lead to wage spirals and therefore ultimately the ECB won’t be forced into a more hawkish mode.
Annalisa Piazza, Fixed-Income Research Analyst, MFS Investment Management
We don’t anticipate any meaningful announcement on future policy steps, given the December 2021 meeting already spelt out quite clearly when PEPP ends and how the APP programme unfolds this year. Market pricing in an abrupt change in policy stance.
As it stands, we maintain our view that the ECB is unwilling to tighten financing conditions and will be willing to wait for further evidence on inflation before starting to remove the ongoing accommodation as abruptly as the market is pricing in. Such a baseline scenario for policy rates is consistent with our view that the short end of the EMU curves will remain well anchored in the current environment of rising global yields.
Since the December ECB meeting, EMU inflation continued to surprise to the upside, hitting a record high level of 5% in December. More information on where inflation has moved to in January will be released just ahead of this week’s meeting, but we suspect headline figures will be above the ECB projections as energy prices have not moderated as anticipated. On the other hand, market inflation expectations have moved lower since the start of the year (5y5y fwd down to 1.8% from 2%). As such, Lagarde is expected to avoid an uber hawkish shift in communication on Thursday. We expect the ECB to stick with the narrative of the ‘temporary’ nature of the current spike in inflation. Another few months of upward surprises in inflation should not lead to any substantial shift in the ECB stance. Some concerns might emerge in March should the updated projections for inflation show an upward revision in the medium term.
Despite the internal division within the Governing Council with regards to inflation, we still expect the ECB to start its slow hiking cycle not before Q2-Q3 2023 and the tone of the February policy announcement will not diverge much from what we heard in December. Lagarde had made clear in one of her recent statements that the ECB has good reasons to not act as quickly as the Fed, reducing risks that ‘peer pressure’ could be the key driver for the ECB action. Future developments for inflation and inflation expectations will be the key catalyst for the ECB to start hiking rates and – by then – several rounds of wage negotiations will have taken place and the ECB will have a clearer picture of underlying inflationary pressures.
