ECB nods toward rate hike risks
Still, President Lagarde felt the need to do more than just acknowledge the elevated inflation outlook, inching closer to delivering rate hikes, even if not today. That said, the President did not commit to any specific course of action, not at all surprisingly given the uncertain backdrop.
The deposit facility rate remains at 2.00% following the ECB’s April policy meeting, an outcome almost universally expected.
Still, President Lagarde felt the need to do more than just acknowledge the elevated inflation outlook, inching closer to delivering rate hikes, even if not today. That said, the President did not commit to any specific course of action, not at all surprisingly given the uncertain backdrop.
The evolution of conditions between now and the June meeting will be key for ECB next steps then, though we retain a low conviction call for no change in rates.
At a high level, we think it is interesting that President Lagarde chose to mention in the press conference that the Governing Council “debated at length and in depth, a decision to possibly hike.” Accompanied by a discussion of the March forecasts, which embedded two rate rises, this seems to be a steer in toward likely policy tightening. Doubly so with Lagarde also suggesting that the hard data continues to evolve in line with those prior forecasts.
Taking just those points in isolation, we would be inclined to change our current stance on ECB rate hikes, and pencil in a dose of tightening for June.
However, as we have observed in our recent commentary, the evidence for second-round effects looks limited in the eurozone, a dynamic also touched on by Lagarde today. In the absence of such dynamics, higher rates risk damaging the economy unnecessarily, repeating prior ECB policy errors. With the June meeting just six weeks away, the hope seems to be that more data can establish whether concerns around second-round effects are justified. We are sceptical. Such dynamics will likely take some time to emerge clearly, if at all, leaving us, on balance, to favour no change in rates again in June, even if that is at odds with both market pricing and today’s communications from President Lagarde.
Indeed, swap markets do not seem to share our lack of conviction following today’s policy meeting.
The implied odds of a rate hike in June stand at 93% as of writing, with close to three full rate increases expected before the year is out. Given our more dovish bias, we also see downside risks for the euro, though like the ECB we will be looking to the data in the coming weeks for validation, or disconfirmation, of our current baseline.