Hawkish tone of the ECB meeting and rate hike

The key central banks can boast of amazing synchronization (interest rate hike by 50 basis points) this week. Unanimity Federal Reserve, the European Central Bank, Bank of England i Swiss National Bank points out and shows that the problems faced by central banks when conducting monetary policy are similar. After Wednesday's Fed meeting, on Thursday investors focused most attention on the decision of the ECB's Governing Council.

The cycle of interest rate hikes continues

European Central Bank, as expected, raised its key interest rates by 50 basis points. Thus, the refinance rate increased from 2.00% to 2.50%. At the same time, the communiqué after the meeting stressed that in the face of a significant upward revision of the inflation outlook, the European Central Bank expects the cycle of interest rate hikes to continue next year. The message of restrictive monetary policy has been clear, and the central bank's goal remains to bring inflation back to its medium-term target of 2.00%.

An important piece of information for the financial system is the announcement of portfolio changes asset purchase programme (APP). From early March 2023, the ECB will not reinvest all maturing securities. It is assumed that the reduction of the balance sheet total will be carried out at the rate of EUR 15 billion per month until the end of the second quarter of next year. The details of the reduction of APP resources will be announced during the February meeting of the ECB. Further actions and their scale will depend on the development of the situation and will be announced at a later date.

Inflation remains a major concern

Inflation is the main factor determining dynamic interest rate increases by the European Central Bank. Inflationary pressure has intensified in recent months, which is reflected in the revision of price growth forecasts for the coming years. In September, the ECB predicted that inflation in 2023 would be at the level of 5.50%, now it is already 6.30%. The situation is similar for 2024, for which inflation estimates have been revised upwards by 1.10 percentage points to 3.40%.

ECB inflation forecast. Source: Own elaboration based on ECB data

Taking into account the prospects of inflation remaining clearly above the inflation target, the continuation of significant interest rate increases is currently the baseline scenario.

In the communication, the European Central Bank also referred to the general economic situation and forecasts regarding GDP dynamics. The central bank sees a significant risk of contraction in the economy over the next two quarters. The main factors responsible for this state of affairs are the energy crisis, the weakening of economic activity in the world, as well as the tightening of financing conditions. However, the ECB projections do not anticipate a negative GDP growth for the entire year. In 2023, economic growth is to amount to 0.50%, to accelerate in the following years and reach the rate of 1.90% (2024) and 1.80% (2025).

Christine Lagarde's hawk

Christine Lagarde, head of the ECB, like Jerome Powell, adopted a "hawkish" attitude during yesterday's press conference. Lagarde pointed out with great conviction that the European Central Bank has a long way to go and consistency in action is necessary. The head of the ECB clearly indicated that the central bank will continue raising interest rates in the amount of 50 basis points for some time. During the press conference there were words indicating the determination of the central bank's actions aimed at bringing inflation back to the target. Christine Lagarde emphasized that the reduction in the pace of interest rate increases should not be treated as a turning point in monetary policy (pivot). What's more, words about the need to take more restrictive actions regarding interest rates in relation to what the market is currently pricing in had very hawkish overtones. The market reaction was not long in coming. Yields on euro area bonds rose very dynamically. In the case of 10-year German debt securities, a jump of 20 basis points was recorded from around 1.90% to 2.10%. The scale of the move for Italian bonds was even bigger and exceeded the level of 30 basis points. Stock indices also performed well. in Germany and France, which were additionally hit by poor data from the US, losing over 3% during yesterday's session.

Summation

Unlike in the US, the end of the cycle of interest rate hikes is not in sight in the eurozone. Inflationary pressure remains high and the macroeconomic projections do not envisage a quick return of the price index to target. Therefore, the European Central Bank is in a difficult position, being forced to tighten monetary policy in recessionary conditions. Risk and uncertainty remain at a very high level, and the coming quarters will allow us to answer the question of whether the ECB's actions are effective and whether the economic situation is developing in the intended direction.

Author Piotr Langner, Investment Advisor, WealthSeed

Disclaimer

This document is only informative material for use by the recipient. It should not be understood as an advisory material or as a basis for making investment decisions. Nor should it be understood as an investment recommendation. All opinions and forecasts presented in this study are only the expression of the author's opinion on the date of publication and are subject to change without notice. The author is not responsible for any investment decisions made on the basis of this study. Historical investment results do not guarantee that similar results will be achieved in the future.