The ECB meeting on Thursday is setting up nicely.

The focus isn't really on the decisions to be taken on Thursday. The immediate policy steps have essentially been pre-announced. It's what happens next that's less certain...

At this meeting the ECB will:

  • End the APP program (Yes, they're STILL doing QE, even with inflation at a gazillion* percent) *8.1%
  • Pre-announce a rate hike of 25bps (or 'at least' 25bps depending on the mood) at the July meeting.
  • Be asked about the spreads/fragmentation risk, and dodge the question

And it's that last point that will be most important. So we'll leave it for last.

What do we 'know'?

President Lagarde published this blog on the 23rd of May πŸ‘‡

Monetary policy normalisation in the euro area
The European Central Bank (ECB) is the central bank of the 19 European Union countries which have adopted the euro. Our main task is to maintain price stability in the euro area and so preserve the purchasing power of the single currency.

But as the expected date of interest rate lift-off draws closer, it becomes more important to clarify the path of policy normalisation that lies ahead of us – especially given the complex environment that monetary policy in the euro area is facing.

Lots of words to essentially say...

This is the problem πŸ‘‡

Core inflation jumped to 3.5% in April. And because all sectors of the economy are being affected, 75% of items in the core inflation basket are now recording inflation rates above 2%.

And this is what we're doing about it πŸ‘‡

I expect net purchases under the APP to end very early in the third quarter. This would allow us a rate lift-off at our meeting in July, in line with our forward guidance. Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.

Translated into normie speak, "very early in Q3" means that QE will end in early July, and a rate hike (likely of 0.25%) will follow at the 21st of July meeting.

Then nothing happens in August because the whole of Europe goes on holiday.

Our policymaking overlords will return to the meeting table on the 8th of September feeling refreshed and tanned, announce another 0.25% hike while proudly proclaiming that "the ECB has exited the negative rate regime" (as if it's a huge achievement to bring rates back to 0%).

And then we'll see what happens next.

That's the plan at least. We'll see how it works out in reality.

Hawks such as Holzmann, Knot, Kazimir & Kazaks are all in the "should at least consider a hike of 0.5% in July" camp. But they seem to be the minority for now.

Economists generally agree too...


Bank of America don't. They totally disagree with the timing and see the ECB hiking aggressively and early πŸ‘‡

  • Our ECB call moves to cumulative 150bp hikes in 2022 (+50bp).
    We were more hawkish than consensus before, and increase that distance.
  • We expect two moves by 50bp in Jul/Sep, and two 25bp hikes in Oct/Dec.
    We hold higher conviction in the total, than the exact trajectory.
  • ECB forecasts are likely to show 2% inflation in 2024. That’s the β€œgo” signal.
    We still think that will eventually turn out optimistic.

The exact path for the size of each hike is more uncertain, but we think consensus can be built for a 50bp depo move already in July (a very close call, but we can’t see the ECB avoiding a 50bp move by September at the latest). That should be followed by another 50bp in September. What happens then is even more uncertain.
We work on the assumption that first, they are unlikely to skip meetings and, second, after 100bp of hikes, they may want to slow down a bit before reassessing the outlook in December with a new set of forecasts.
To us that means 25bp in October and then, facing a much weaker outlook in the December forecasting exercise, another 25bp.

All of which seems reasonable. But this is the ECB, and they're not known for doing anything fast...

Stiull, if they did decide to go harder/faster, fragmentation risks are bound to emerge.

Closing The Spreads

The spread of borrowing costs between eurozone nations is a key issue.

Think of Germany as the prime (lowest yield), while Italy, Spain, Greece are the junk (highest yield).

The spread between German & Italian bond yields is always monitored as THE key benchmark of eurozone stress.

On the left, German and Italian 10 year bond yields. On the right, some rules of thumb to analyse the spread between them πŸ‘‡

Now, if spreads were to widen firmly into that 2-3% dangerzone, the ECB would probably respond with some calming words.

If that doesn't do the job, the ECB is supposedly working on a backup plan...

BBG April 2022

FT June 2022

Presumably, any tool would involve buying a larger share of the peripheral bonds as the ECB reinvests maturing assets on their €8.8 trillion balance sheet...


No quantitative tightening happening here!

But will the market find it credible?

Lagarde is bound to be asked about this tool in the presser. She'll probably dodge the question as usual, but we live in hope of details...

The Euro: Strength Or Weakness?

We discussed the difficulties of being an energy importer with a weakening currency here πŸ‘‡

There’s Another European Crisis Brewing
Could the ECB intervene... When energy prices are soaring, what good is a weaker currency to you?
Move Fast & Break Things
Move fast and break things is the Fed’s new mantra. How far will the collateral damage extend once the dust settles? Tech giants? China? The euro?

And this is other spread the EU needs to watch... πŸ‘‡

On the left, US, Italian & German 2 year bond yields. On the right, the spread between US & German 2 year bond yields.

Interest rate differentials are a key driver of FX rates. Further widening between US & German 2 year yields could see EURUSD heading back to the 2022 lows, and potentially parity.

On the other hand, if German yields can close the gap, we could see a euro rally, especially if the Fed were to signal a pause in their hiking cycle.

Too early for that now, and we still see the odds as stacked in favour of a stronger USD in this cycle (Fed keeps hiking above neutral) but still something to keep an eye out for...

One final risk is the French National Assembly this Sunday (12th) and next. Macron's government could fall short of an absolute majority, which would make legislation trickier to pass πŸ‘‡

France’s Macron could lose lower house majority, polls show
President Emmanuel Macron could fall short of an outright majority in France’s National Assembly, which would pose a major hurdle for his planned second-term reforms, two polls showed, less than two weeks before the first round of voting.

A minor risk in isolation, but all part of the wider picture for the eurozone, and the ability to respond to inflation and/or economic slowdown.

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