The ECB met market expectations yesterday in keeping their base interest rate unchanged at 0% while signalling a 25bpt rise for their next meeting on 21st July. The ECB’s tone also reaffirmed the market’s expectations of two subsequent 0.25% hikes with the general view being that rates will hit 2% by Q2 2023 given Lagarde’s view that a “gradual but sustained path of further increases in interest rates will be appropriate.”Regarding the ECB’s balance sheet, the committee stated that it would end asset purchases on 1st July, though continue to re-invest in some maturing securities. This will mark the end to the Eurozone gargantuan APP and PEPP programmes in addition to their corporate bond-purchasing programme, under which the level of companies’ debt owned by Frankfurt has risen from a pre-pandemic level of €140bn to €341bn today. The total size of the ECB’s balance sheet currently stands at €680 billion having risen from €569 billion in 2020 and have been behind the Fed and BoE in drawing a close to it. Earlier in the year the general market consensus was that the ECBs QE programme would end in September, however given rising inflation (currently at 8.1%), the requirement for further monetary tightening and rhetoric from some of Frankfurt’s key players meant that the market had pretty well expected yesterday’s QE announcement.
As such, yesterday’s announcement from the ECB was more or less an unchanged melody, both concerning rates and their asset purchasing programme. Though as we look ahead to their next meeting on 21st July there are a growing number of institutions, including Goldman Sachs which are forecasting a 50-basis point hike in September and October. This follows the ECB’s Klaas Knot stating earlier last month that a 0.5% hike in July and September was “clearly not off the table.” As such, all eyes are now on how fundamental data (chiefly inflation figures at the end of the month) may play into policy makers’ decisions and the markets will be paying close attention to policy maker’s speeches over the next six weeks to gain an indication over the ECB’s next move.
Fragile Forecast From Frankfurt
Citing the conflict in Ukraine as the primary reason for hindered output going forward, Frankfurt revised down their growth projections for the 19-member euro area, estimating real GDP growth to hit 2.8% in 2022, while dropping to 2.1% in 2023. Though the projections for 2022 represented a considerable fall from their earlier forecast of 4% in February, the ECB revised up their forecasts for 2024, estimating it to hit 2.1% in 2024.
Concerning inflation, the ECB also stated that they expect inflation to average 6.8% over 2022, while falling to 3.5% in 2023 and 2.1% over 2024 – all of which were higher than their March projections. The persistence of inflation and prospect of slowing growth has thus seen the term ‘stagflation’ gain greater currency in common parlance and is a reminder of the ECB’s perpetual balancing act in trying to curb inflation while not stifling growth.
Bond Market Reactions
As we looked at yesterday, speculation over the health of the Eurozone’s component parts has hit bond markets with the risk spread between Italian and German ten-year bonds growing to 200bpts – a considerable adjustment from around 140bpts earlier this year. Indeed, following the announcement yesterday and subsequent report, Germany’s ten-year bonds rose by 0.08 percentage points to 1.44% while Italy’s rose as much as 25 basis points to 3.7%. Similarly, the French ten-year bond yield hit an eight-year high and pushing above 2%, signalling further concerns over the wider economic climate. This means that the difference between the cost of borrowing for the Italians and Germans is now at its greatest level since the early months of the pandemic.
The ECB’s fragile economic outlook and monetary announcement exacerbated the selloff of European stocks seen over the last week with both the German Dax and European wide Stoxx 600 falling by around 3% over the last five sessions. This was a similar story in the UK, where the FTSE 100 has seen five consecutive days of declined as investors weigh on the tightening of the monetary supply, recession forecasts for next year and the cost-of-living crisis. In the States, fears over a high inflation print today saw the Nasdaq fall 2.8%, while the DowJones and S&P 500 recorded the worst session in three weeks.
WTI crude futures have slipped slightly to around $121dpb this morning as investors speculates on the impact of Shanghai districts locking down and imposing mass testing. Of course, China is the world’s largest importer of Crude oil accounting for a quarter of global imports and thus any news on the extent to which the CCP may close down key economic hubs to combat Covid outbreaks is having a major impact on the energy markets. Nevertheless, this week has seen a considerable appreciation of WTI rising from around $115dbp a week ago as investors speculate on low inventories, OPEC’s below-target production and the EU’s partial embargo on Russian crude oil.
Have a great day.