🏦🇪🇺 ECB December Meeting Desk Commentary

UBS:

The ECB press conference was uneventful with President Lagarde sticking to her written remarks and re-reading paragraphs. Inflation is projected to drop back to 1.8% by 2024, which is no surprise but means the ECB retains a dovish bias. Of course, its just a forecast and at some point the hawks will likely challenge it and push for early hikes. For now though, the hawks will be satisfied that the total additional asset purchases amount to just EUR9Obn next year, which means for Italy only about 70-80% of issuance will be absorbed by the ECB. Still, adding additional asset purchases when inflation is almost 5% could certainly get Lagarde into trouble if price pressures do not ease off fairly quickly.

For the market, the conclusion remains 1) hawkish on QE and hence negative for fixed income and particularly periphery 2) not hawkish (yet) on rates with Thursday's decision allowing for a hike in Jan 2023 at the earliest, and hence not much support for the EUR in my view.

The inevitable jockeying emerges from the European Central Bank with anonymous sources quoted by Reuters that are on the hawkish side. The hawks on the committee felt there needed to be greater emphasis on upside risks to inflation and as such they also disagreed with the one-year extension of PEPP reinvestment and that there wasn't an end date for APR. The headlines suggest the governors of Austria, Belgium and Germany disagreed with parts of the ECB's decision.

The EUR swap curve was better bid on Thursday, led by the front-end, with the rally exacerbated by the ECB raising their HICP forecasts. For the years 2021-2023, the ECB announced their HICP predictions of 2.6%, 3.2% and 1.8% (these had previously been 2.2%, 1.7% and 1.5% respectively.) 1y rallied 16bp and the curve continued to flatten in the front-end, 1s 2s and 2s5s by 5bp each The long-end saw an almost parallel shift upwards of 3bp, with 10y closing at 195.

Westpac:

Expectations for ECB to add additional APP (Asset Purchasing Programme) buying as it drew an end to its PEPP (Pandemic Emergency Purchasing Programme) had been enforced by “sources” in financial newswires indicating that this would be discussed.

The other key issue for markets was whether there would be a sufficient lift in ECB’s Staff projections to suggest that inflation would be at their 2% target at the end of their forecast period, something that has evaded the ECB for over a decade.

Staff have lifted the economic backdrop, with GDP growth lifting slightly in 2022 to 5.1%y/y and being sustained at 2.9%y/y in 2023. However, the impacts of Omicron and the surging case counts in Europe into 2022 have seen 2022’s GDP marked down to 4.2%y/y (from 4.6%y/y). However, the profile for unemployment has improved markedly. Unemployment is now expected to drop below 7% in 2023 and be only 6.6% in 2024. The prospects for inflation being more sustained are also apparent, with the 2023 level lifting from a decidedly under impressive 1.5%y/y in September’s update to 1.8%y/y and remaining at that level in 2024. Although still being under the ECB’s 2% target, the balanced risks in the outlook and the assumed path of 3-month Euribor indicate that the ECB is guiding the markets towards rates moving, if very moderately, in 2023.

EUR had initially firmed, partly as GBP spiked higher against EUR, as the more favourable projections for growth, inflation and assumed Euribor were assessed. EUR/USD rose +.06% to 1.1360 prior to USD rebounds unwinding the moves and EUR/USD traded back to 1.1315 as Europe closed.

ING:

The reasons why Europe's central bank didn’t go any further and remained very dovish can be found in the latest round of macro projections. The ECB expects a soft patch for the eurozone due to the fourth wave of the pandemic and the effects of the Omicron variant. Interestingly, the sentence that “if price pressures feed through into higher than anticipated wage rises or the economy returns more quickly to full capacity, inflation could turn out to be higher” could also be read as a “the risks to the inflation outlook are tilted to the upside” - in former times a very hawkish statement.

We think the ECB’s own economic models have clearly underestimated the current inflation surge, both in terms of size and duration. The main reason for this poor forecasting performance is the fact that no standard economic model, based on historic experiences and relations, was able to predict supply chain frictions and the mismatch of supply and demand in and after a pandemic. Somewhat more economic intuition, however, could have helped. While sticking to the models makes sense for the ECB as it gives some kind of control, it is surprising to see that the bank seems to have no doubts at all that wage settlements and wage growth will still follow traditional patterns and could not show a post-pandemic behaviour as well.

Against all of the above, we stick to our view that the first rate hike will come earlier rather than later and it could be as early as the first half of 2023 as inflation, after a temporary slowdown once all post-pandemic effects have petered out, will structurally be higher than the ECB currently expects. All in all, despite all this juggling between dovishness and hawkishness, the ECB today also marked its very own tapering. As so often in Europe, it is more complicated than elsewhere in the world, but the fact is that net asset purchases will – one way or the other – be reduced from currently around €80bn per month to €20bn within less than one year. It is obvious that the ECB wants to push out any rate hike speculation for as long as possible. However, don’t forget that it was only three months ago that ECB president Christine Lagarde said that “the lady is not tapering”. It is a cautious taper for now, but we think that rate hike speculation will emerge much earlier than she or the wider European Central Bank might like.

BBVA:

First, the reinvestment of PEPP purchases will be extended by one year to end 2024, and this reinvestment will be flexible in asset classes and jurisdictions. Special emphasis was put on the fact that Greek bonds will be included now. Second, APP purchases are increased to a monthly amount of €40bn in 2Q22 and to €30bn in 3Q22, to then revert to the current €20bn afterwards. This implies €90bn more for APP above the current purchases to substitute for the expiration of PEPP, which is below what we were expecting. Third, TLTROIII special period under which entities could benefit from an interest rate of up to -1% will end in June 2022, but this will come along with a calibration of the tier multiplier in order to alleviate cost for banks in an environment of increasing liquidity. The ECB also stressed that all these measures continue to be flexible, and that the PEPP could be resumed to counter negative shocks of market fragmentation related to the pandemic.

Overall, the ECB was relatively hawkish as the main instrument to smooth the suppression of PEPP, APP, received less money than expected, while the measures on liquidity also imply some hardening. Moreover, the pace of APP purchases for 2022 seems now settled and implies that tapering of QE has started. The stress on flexibility and the readiness to reopen PEPP if needed is a welcome measure, but not enough to compensate for it. On the key issue of medium term inflation projections, they remain on the soft side.