ECB: the APP reinvestments will stop in July


Annalisa Piazza (MFS IM) | The ECB announced today its decision to hike policy rates by 25bp after hiking by 50bp at its March meeting. Inflation is high and pushing it down to its 2% target in the medium term remains the ECB top priority. However, a slower pace of hiking was not a surprise as current levels of rates are already in restrictive territory and the economic picture for the Eurozone is not clear cut and more caution seems to be a good compromise for the time being. We expect another 25bp rate hike in June and the updated projections will help to define future steps.

The ECB’s tone on inflation remains hawkish but it seems that data are consistent with no upward revisions for inflation in the medium term are on the cards. The ECB acknowledged that past increases in rates are transmitted forcefully, suggesting the ECB is carefully looking at how the transmission of past policy moves add downside risks to the economy in the medium term (and implicitly on inflation). Such considerations add a modest dovish twist to the decision today.

The data dependency of future policy moves has been confirmed and the ECB will continue to monitor its three pillars (inflation outlook, underlying inflation and transmission) when making future decisions. As for further policy measures, the APP reinvestments will stop in July as we expected whilst PEPP reinvestments will continue flexibly.

As per the TLTROs, the tone seems dovish as suggests that the Governing Council will regularly assess how targeted lending operations are contributing to its monetary policy stance. The ECB doesn’t seem to be keen on creating further disruption to the banking sector.

Tighter financing conditions as described by the latest ECB Bank Lending survey show how the past moves in policy rates are filtering into the real economy. The banking sector remains robust despite the recent ‘wobbles’ but risks are skewed to the downside for growth as demand for loans has rapidly deteriorated. Lagarde often referred to the BLS during the press conference as a key factor they are looking at and the sharp decline in demand for loans seem to be a reason of concern as shows past policy hikes are pushing the economy down.

Markets are currently pricing in terminal rates at around 3.5%-3.65% and policy rates are expected to remain pretty much stable until early 2024. The market has rallied a touch after today’s decision as the slower pace of hiking is interpreted as a sign the ECB is now closer to the end of its hiking cycle.

We are cautious in starting new steepening trades in core Euro curves as the market will wait until signs of moderation in core inflation before starting to price in rate cuts by the ECB. That said, a more neutral duration stance makes sense given the wider backdrop.

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The Corner
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