🏦🇪🇺Desk Commentary: ECB May Rate Decision

HSBC:

• The European Central Bank's moving to a smaller interest-rate rise of 25 basis points on Thursday from 50 basis points previously makes sense. Not only is core inflation stabilising, albeit at high levels, but a dramatic tightening of monetary conditions and credit growth points to a significant economic slowdown later this year.

• Nevertheless, the ECB is concerned about the spillover effects from headline inflation into wage growth and could raise rates further over summer, unlike the Federal Reserve which is likely to pause rate rises

TD Securities:

• The euro's decline after the European Central Bank raised interest rates by 25 basis points on Thursday reflects the fact that some market participants were disappointed, as they expected a 50bp rise. We think the EUR reaction boils down mostly to disappointed positioning. Markets are long EUR, expecting it to rise, although this doesn't look extreme.

• The ECB remains data dependent on its decisions like the Federal Reserve and this may result in further foreign exchange volatility. However, the ECB sounds more "hawkish" than the Fed as there's no sign the ECB is finished raising rates whereas the Fed has signalled a pause.

ING:

• The longer the press conference lasted the more Lagarde seemed to emphasise the need for further rate hikes and increasingly sounded hawkish. In all honesty, what started off as a clear message of a meeting-by- meeting approach and data dependency ended with more questions than answers. Maybe it was just a sign of the fact that the ECB is increasingly divided about what to do next

• Leaving aside the press conference, it will be hard for the ECB to return to 50bp rate hikes in the current macro environment with the lagged impact from previous hikes, banking turmoil, and subdued growth but still sticky inflation. In this base case scenario, it will be equally difficult to hike rates more than one or at most two times. In fact, the risk is high that every single additional rate hike from here could turn out to be a policy mistake further down the road. Instead, keeping interest rates high for longer after another rate hike in June will probably be the next compromise between the doves and hawks. It would buy the ECB time to see its tightening up to now fully unfolding. The decision to stop APP reinvestments as of July also points in this direction

Natixis:

• The ECB also announced today that it “expects” reinvestments of its APP portfolio to stop by July this year, while reinvestments of the PEPP portfolio will continue “at least until the end of 2024”. The average monthly redemption of the APP portfolio is €25 billion. To put this into perspective, the holding of bonds acquired under the APP stood in April at €3.2 trillion. Mrs Lagarde also stressed that the market had digested, so far, the reduction in APP reinvestments well and that the additional tightening was, based on ECB estimates, moderate. Finally, Mrs Lagarde was sanguine with respect to the effect of the repayment of TLTOR loans in the coming months. This suggests, barring any new disruptions, that the ECB does not plan to offer any new long-term refinancing operations to banks

Scotiabank:

• The pricing for the ECB’s June meeting has only marginally edged lower, still seeing 28bps in choppy dealing as markets adjust. Toss-up odds are roughly preserved for the July meeting (14bps priced in). When compared to what’s seen for the Fed, i.e. just over 75bps in cuts by year-end, this is a hawkish view from markets that today are again struggling with a regional banks meltdown. The EUR’s performance may be the cleanest read of the reaction in markets to the ECB. The currency is down 0.4% on the day to the 1.10 level (from the high-figure area overnight), lagging all majors barring the BRL, showing disappointment among some that the bank did not launch another half-point hike

• We don’t expect more than two hikes of 25bps in the Eurozone, at most, under current economic conditions and ECB guidance. We now have to wait until inflation data scheduled for late-May to refine these expectations, with comments from policymakers over the next few weeks also worth watching—although, ultimately, it’s all about the data.

ABN AMRO:

• Our base case is for two further steps of 25bp in each of the June and July meetings. However, the sharp tightening of bank lending conditions and collapsing loan demand suggest the risks are titled towards a somewhat earlier end of rate hikes. In any case, we think that as the tightening feeds through, the economy is likely to prove much weaker than the ECB currently expects in the second half of the year. As such, we expect an easing cycle to start from around the turn of the year.

Danske Bank:

• EUR/USD initially had a knee-jerk reaction towards 1.1000 on the back of the relatively dovish 25bp rate hike from the ECB. While general macro optimism in the euro area, narrowing of rates spread, and lower energy prices have all been a tailwind for the cross lately, we remain bearish on the EUR/USD on the strategic horizon. As the Fed likely has concluded its rate hiking cycle and the ECB likely has a couple of rate hikes left, we think focus will increasingly turn to relative growth differentials. Furthermore, we think that there is a larger potential for Fed rate cuts being priced out than additional rate hikes from the ECB being priced in, which could be USD positive. Regarding growth differentials, we have a hard time comprehending why the euro area should be in a better position than the US. We acknowledge the current boost to the euro area economy, but we think it will prove temporary. Lastly, the regional bank stress in the US could be a risk to our call, but that is admittedly difficult to predict, and we first and foremost see regional bank jitters as a symptom of monetary policy tightening than a core risk for systemic risks. In sum, we think that macro fundamentals look relatively less gloomy in the US – relative terms of trade, real rates, and relative unit labour costs should favour the USD in H2 and push EUR/USD lower towards 1.06 in 6M. In the short-term, the EUR/USD looks more rangy