Van Lanschot Kempen: ECB not done hiking

May 5, 2023

Today, the ECB hiked the deposit rate by 25 basis points to 3.25%. A 50 basis points hike was seen as a slight possibility, but the ECB decided to slow the pace of rate hikes after three 50 basis points steps.

Markets were somewhat wrong-footed by the ECB today. In the press statement released before the press conference, the ECB said that inflation continues to be too high for too long.

This and the ECB’s message that future decisions will ensure that the ECB’s policy rates will be brought to levels sufficiently restrictive to return inflation to the ECB’s 2% target, would hint at further rate hikes. But the ECB admitting that past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain, could be seen as the end of the tightening cycle approaching.

Thus, the German 2-year yield fell by 10 basis points after the press statement and the 10-year yield by 4 basis points. The euro weakened.

However, when Lagarde at her press conference described the mood in the policy meeting, perceptions changed. The ECB’s policymakers are determined to fight and tame inflation. Every policymaker thought that a rate hike was necessary. Lagarde emphasized that this slowdown in the pace of tightening is not a pause.

More importantly, the ECB has more ground to cover to get rates to a sufficiently restrictive level. So, there are more rate hikes to come. The ECB did not commit to any number of hikes or a final level to be reached with policy rates. Still, Lagarde’s comments pushed up 2-year and 10-year yields at or slightly above the level before the press statement.

Credit conditions and especially bank lending standards are an important factor for the ECB. The tightening of these standards as evident in the Bank Lending Survey the ECB published just days before this meeting, was probably a prime reason for the ECB to slow down the pace of rate hikes to 25 basis points.

Despite tighter credit conditions, the ECB will continue with the reduction of its balance sheet, by not fully reinvesting maturing bonds. And as planned, it will discontinue reinvestments of its Asset Purchase Programme by the end of June. That will speed up the balance sheet reduction.

Interestingly, while Lagarde seemed to have convinced markets of the ECB’s determination to fight inflation and yields had risen, they slipped back towards the end of the press conference. Probably this was because Lagarde emphasized that the ECB was not giving any forward guidance on rates and that it is fully data-dependent.

So, at the end of the press conference the 2-year yield was down 12 basis points, the 10-year yield 7 basis points and the euro 0.4%. While equities were down from the previous day’s close due to losses in the morning, they gained 0.2% from before the release of the press statement.

All in all, we think Lagarde was not able to fully convince markets of the ECB’s determination to fight inflation. One more 25 basis point rate hike is fully discounted by the market. We think there is a clear risk that the ECB will have more ground to cover than that.