What The Markets Expect From The ECB Today
Courtesy of Bloomberg and Newsquawk
The European Central Bank is likely to focus its efforts on damping down expectations for a rate hike as early as next year citing its estimates that will show inflation may still fall short of its target within the forecast horizon. At the same time, uncertainty presented by Omicron could impair the bank’s ability to provide certainty on future of APP. Sources have suggested policymakers could present a limited and temporary boost to APP. Economic projections will see the debut 2024 inflation forecast.
As Bloomberg notes, it’s possible that the ECB may announce that it plans to end its pandemic-related bond purchases, set out terms of its next version of cheap loans and defer all other complex decisions — such as an increase in its longer-running asset purchase program — to a later meeting. That will buy it time to see how the omicron variant evolves.
If, on the other hand, it decides to show its hand, this is how it may proceed:
PEPP & APP:
Guidance so far from the ECB suggests that the PEPP program will end in March as planned. However, the crucial question for the markets is what the central bank will do with its longer-running asset-purchase program.
Expectations are that the pace of APP purchases will double for at least three months from April before moderating to current levels by October.
It’s also eminently possible that the ECB decides to scrap monthly purchase amounts and vows to spend flexibly and as much as financial-market conditions warrant. Nomura’s George Buckley suggests that the ECB may also make the end point of APP more explicit.
The ECB may be keen to ensure some continuity and offer cheap loans to lenders, although the key question will be at what rate it will offer them.
As things stand, banks can borrow as much as 50 basis points below the deposit rate.
With Bloomberg already reporting that the ECB’s inflation projections for 2023 and 2024 will be below its 2% target, the governing council will have scope to damp down expectations for a premature rate increase next year.
While the Fed’s dot plot for 2022 was more hawkish than expected, the ECB will be keen not to repeat the policy mistakes of the past and ensure that there are more than transitory forces at work in pushing up prices.
Overall, the Fed’s hawkish pivot overnight will mean that President Christine Lagarde will be more strident in her post-meeting briefing to send a message of cautious optimism and play down expectations for the ECB to follow closely in Fed’s footsteps. Some months ago,
Lagarde famously remarked that “The lady isn’t tapering.” This time around, she may want to drive home the message, “The lady isn’t hiking.”
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Below is a more detailed summary of what to expect, courtesy of Newsquawk
OVERVIEW: The December meeting had initially been eyed as the meeting at which, the decision on the Bank’s bond-buying operations beyond PEPP would be decided. The Omicron variant and various lockdown measures across the Eurozone presented a threat to this view and subsequently sources suggested that February might be a more opportune time for such a decision. That said, a separate sources piece noted that policymakers could opt for a limited or temporary boost to its APP as of April 2022. The magnitude of any increase will need to be forged as part of a compromise between the hawks and the doves on the Governing Council and thus has presented an element of uncertainty to the upcoming decision. Regardless of the outcome, President Lagarde will likely stress that bond-buying will be conducted in a flexible manner in order to maintain favourable financing conditions in the Eurozone. Furthermore, Lagarde will also likely reaffirm that interest rates are unlikely to rise in 2022. For the accompanying economic forecasts, the near-term projections will likely be dismissed given the cut-off date for submission. However, focus will be on the debut 2024 projections and how the inflation forecast aligns with the ECB’s mandate.
PRIOR MEETING: As expected, the ECB stood pat on rates, and held the size of its PEPP envelope at EUR 1.85tln. The statement that accompanied the announcement saw little in the way of tweaks with the Bank refraining from enhancing its forward guidance on rates. During the press conference President Lagarde stated that the criteria for hiking rates are unlikely to be fulfilled in the coming year. On the inflation front, Lagarde reiterated that the GC envisages inflation rising further before declining in 2022. However, the President conceded that the current phase of high inflation will last longer than expected and noted that if supply bottlenecks persist, this could see price pressures becoming more persistent. On life after PEPP, as expected, Lagarde provided little in the way of clues about how the December showdown on the matter was taking shape other than stating that she believes PEPP will conclude next March. Note, it was commented that the dominant view on the GC is that volumes of QE matter more than duration.
RECENT DATA: Flash headline Y/Y CPI for November printed at 4.9% with the core (ex-food and energy) metric coming in at 2.6%. In terms of an outlook for inflation, ING doesn’t expect inflation to drop much below 2% for the latter parts of 2022, adding that “while second-round effects are largely absent for now, medium-term price pressures are increasing”. Q3 Eurozone GDP was confirmed at 2.2% Q/Q, however, this is very much regarded as stale by the market given the fluidity of the COVID situation. More timely survey data from IHS Markit saw the November composite PMI rise to 55.4 from 54.2. However, economists at IHS Markit cautioned that “An improvement in the rate of economic growth signaled by the eurozone PMI looks likely to be short-lived”. In the labour market, the Unemployment rate continued to fall in October to 7.3% from 7..4%. However, mounting restrictions across the Eurozone clearly present a risk to the declining trend, particularly if government support schemes are limited on the jobs front.
RECENT COMMUNICATIONS: Ahead of the meeting, ECB President Lagarde (3rd Dec) cautioned that it is not known how quickly Omicron will propagate within the Eurozone, but another COVID wave was factored into the Bank’s adverse scenario and we are still in that range. On policy, the President stated that the ECB will need to give markets some policy guidance in December and that under the current circumstances, she is confident that PEPP will stop in March. Influential Executive Board member Schnabel highlighted (23 Nov) that inflation risks are skewed to the upside and she sees diminishing returns and increasing side effects of QE. However, at a follow-up speech (29th Nov) the central banker noted that inflation is expected to decline gradually in the coming months and believes that inflation has peaked in November. Chief Economist Lane (18th Nov/pre-Omicron) was of the view that supply bottlenecks will ease from here and he is not seeing inflation expectations moving above the ECB’s target. VP de Guindos has noted that the current phase of higher inflation could last longer than previously thought, but there is no evidence of second-round inflation effects. In terms of the hawks on the Governing Council, Austria’s Holzmann has stated that he sees it as unlikely that inflation in the Eurozone will fall below 2% next year, whilst outgoing German representative Weidmann is of the view that PEPP’s flexibility should not be transferred to other programmes; it remains to be seen if his successor will share this viewpoint. At the more dovish end of the spectrum, Italy’s Panetta has cautioned that a premature tightening of monetary policy could turn the supply shock into a prolonged recession and that policymakers should continue to look through the current inflation spike.
RATES/TIERING/TLTRO: The ECB is expected to stand pat on rates with the deposit, main refi and marginal lending rates to be held at -0.5%, 0.0% and 0.25% respectively with policymakers at pains to communicate that 2022 is unlikely to see a move on rates by the Bank despite markets pricing in a 10bps hike to the deposit rate by December of next year. One continued area of focus on interest rates is the ECB’s current forward guidance that policymakers expect APP “to end shortly before it starts raising the key ECB interest rates”. Some desks are of the view that the inclusion of the word “shortly” is too restrictive and in the event that the GC has fulfilled its inflation objective, removing the word “shortly” could allow a quicker conclusion to asset purchases without having to commit to a subsequent rate hike. However, it is doubtful whether such a development will take place at the upcoming meeting. Elsewhere, policymakers will need to make a decision on the future of its TLRO programme with the final auction of its current round to take place this month.
Guidance from Germany’s Schnabel has suggested that such a decision does not need to be made this month and as such H1 2022 is seen as a more likely timeframe for such an announcement. When a decision is made, it is likely that pricing of the operations would be less favourable than the current 50bps beneath the deposit rate. On the tiering multiplier, again, this is unlikely to be a decision for the upcoming meeting and more of a 2022 story, however, it is expected to ultimately be raised from the current level of 6, albeit the desired magnitude of the necessary increase is an unknown.
BALANCE SHEET: Focus for the release will largely fall upon the Bank’s bond-buying operations with PEPP set to draw to a close in March, as recently suggested by President Lagarde. For Q1 2022, purchases are likely to be conducted at a moderately lower pace under PEPP than seen in Q4 2021 with UBS noting that the Q4 purchase pace thus far is actually running at a higher clip than seen in Q3 which is contrary to current guidance from the Bank. Additionally, a recent sources piece suggested that policymakers are considering PEPP reinvestment tweaks to address any market stress and may expand the reinvestment period in its emergency bond programme. However, the greater unknown for the market is how the Bank intends to continue buying bonds after PEPP concludes. The December confab up until recently had been earmarked as the meeting at which a decision around “beefing up” its traditional APP was set to be taken in a move that would ensure that favourable financing conditions would be maintained after PEPP. However, the emergence of the Omicron COVID variant and mobility restrictions around the Eurozone have complicated this picture. A sources piece (December 1st) noted that policymakers are increasingly concerned that outlook is too murky for a comprehensive policy decision in December and therefore the decision on recalibrating APP may need to wait until February. From a data perspective, waiting until the February meeting (besides gaining more clarity on Omicron) would allow policymakers to digest the release of Q4 GDP (Jan 31st) and Jan CPI (Feb 2nd). However, more recently (December 9th) a separate sources piece stated that a decision on APP could be unveiled at the upcoming meeting in an attempt to form a compromise between the hawkish and dovish elements of the Governing Council. The compromise would involve enhancing the APP (currently EUR 20bln/month), but imposing limits on the size and any time commitments. This could be achieved by either a) announcing a purchase envelope that would run until the end of 2022 and not have to be spent in full or b) increase purchases for a short period and continue them thereafter at a slower pace (subject to review). Note, on December 3rd President Lagarde remarked that the Governing Council will need to give markets “some policy guidance” and therefore an announcement of sorts is expected, however, the extent of which is still subject to speculation by the market. On balance, UBS expects a decision on life after PEPP to be taken this week, but recognises there are clear risks to this view. On APP, UBS expects the ECB to commit to an additional EUR 150-250bln APP envelope for a 6-9 month period which would aim to avoid a cliff-edge as PEPP concludes. Additionally, such an envelope need not be used in full and would not see the ECB drop the capital key or raise issuer limits. Greece could be included in the programme on a temporary basis. Capital Economics expects the ECB to announce a decision to double the pace of its monthly purchases under APP to EUR 40bln as of April 2022 until at least the end of next year. Regardless of the outcome, President Lagarde will likely reaffirm the Bank’s commitment to purchase flexibly under its bond-buying operations in order to maintain favourable financing conditions in the Eurozone.
PROJECTIONS: For the accompanying macro projections, the near-term forecasts will need to be viewed on the basis that the cut-off point for formulating the estimates will have been before the emergence of the Omicron variant. Nonetheless, on the inflation front, UBS expects upward revisions to the ECB’s projections which would see 2021 nudged higher to 2.6% from 2.4%, 2022 to 2.7% from 1.7%, 2023 to 1.6% from 1.5% with the debut 2024 print seen at 1.7% and thus below the Bank’s 2% target. From a growth perspective, desks (inc. UBS and Danske Bank) look for the 2021 projection to be held at 5.0% with 2022 to be cut to somewhere around 4.2-4.3% from 4.6%. 2023 could see a minor nudge higher to 2.2% from 2.1% with the 2024 forecast expected at around 1.6%.
Thu, 12/16/2021 – 07:32