By Bas van Geffen, Senior Macro Strategist at Rabobank
The ECB hiked its rates by another 75bp as fully expected. Alongside the rate increase, the Council made a couple of adjustments to their statement. Most notably, the ECB added that “they have made substantial progress in withdrawing policy accommodation”, and the guidance that the ECB expects to hike “over the next several meetings” has been omitted from the statement. Markets interpreted both as dovish signals, but we don’t think that that was the ECB’s intended message.
President Lagarde said that the Council “are turning their back to forward guidance,” which means that our jobs as strategists are getting just that bit more interesting again. In what felt like a bit of a throwback to the Bundesbank’s style of setting policy rates (i.e., much more opaque), Ms. Lagarde did not comment much on markets’ dovish interpretation of yesterday’s press statement. “We’ve got to do what we’ve got to do. Our job is price stability. Markets have to do what they have to do.”
And markets did what they did. However, traders squarely focused on the dovish elements in the press conference. The topic of recession came up more often, and Lagarde reminded markets that the ECB has raised rates 200bp over the span of just three meetings – adding that this would be taken into account at their next meeting. Euro money markets priced out the odds of another 75bp move in December (to an implied expectation of just 53bp) and lowered their expectations of the terminal rate by 25bp. Bonds were bid, sending yields lower across the board.
Risks of a smaller hike are clearly increasing with each policy meeting. Still, we don’t subscribe to this dovish interpretation without any evidence that the inflation outlook is actually improving. First, as noted above, we believe the ECB mainly sought to give itself more options, not signal that it will take a more dovish stance. And with the ECB having underestimated inflationary pressures –and its own hiking cycle– to date, it’s hard to see why they would now be willing to set themselves up for a slowdown in December already.
Yet, the hawkish parts of Ms. Lagarde’s statement seem to have been lost on markets. She noted that even if the ECB is nearing the ever-elusive ‘neutral rate’, it is by no means a given that the ECB will consider that the endpoint of its hiking cycle. In other words, the ECB may see the need to move policy into restrictive territory: “price pressures are evident in more and more sectors,” which is likely to support wages.
This morning’s inflation data are once again a reminder that inflation may not give the ECB the luxury of slowing down. First, there was the German region of North Rhine-Westphalia reporting an acceleration of inflation to 11.0% y/y in October. And the French inflation estimate, at 6.2% y/y, came in well above expectations of 5.8%. This is leading to some retracement of the moves seen in money markets yesterday. That was, however, followed by a lower HICP in Spain – though the headline decline was not matched by the core measure. With several inflation data points to follow, trading will probably remain volatile [ZH: the final German HICP came in at 11.6%, much hotter than the 10.9% expected]
While markets were busy interpreting the ECB’s latest rate hike and statement, the ECB also implemented two policy changes that reduce the interest it pays to banks – or as Lagarde explained it, to keep these instruments in line with the required policy setting. First of all, the ECB ended the TLTRO arbitrage, as expected. Surprisingly, the Council did not see the need to devise some elaborate scheme to accomplish this. Instead, the ECB decided to simply amend the terms of the TLTRO loans – despite potential legal risks it could bring.
Secondly, the ECB has moved to remunerate banks’ required reserves against the deposit facility rate, whereas this used to be the main refinancing rate. According to the ECB, this “better aligns minimum reserves remuneration with money market rates”, i.e., the ECB argues it was overpaying on required reserves, considering that money markets are trading near the lower-end of the corridor. That may be true, but if so, that has been the case for years now.
That does beg the question – why now? Note that DNB President Knot sent out a profit warning earlier this month. Several policymakers said at the time that the ECB’s policies are driven by the central bank’s inflation goal, and not by a profitability aim. Nevertheless, yesterday’s changes suggest that the ECB is trying to salvage some of its buffers.