La Française: A cautious rate hike, the first in 11 years, and the firepower of the new anti-fragmentation tool

La Française: A cautious rate hike, the first in 11 years, and the firepower of the new anti-fragmentation tool

19 juli 2022

ECB
ECB Europees Centrale Bank.jpg

Pre-ECB commentary by François Rimeu, Senior Strategist, La Française AM

At the July meeting, the European Central Bank (ECB) will confirm its policy sequencing. The main focus will be the anti-fragmentation scheme named “Transmission Protection Mechanism”.

Please find below what we expect:

  • As preannounced, the ECB will increase its three key interest rates by 25 bps after having ended its Asset Purchase Programme (APP) on 1 July; we do not expect the ECB to surprise markets with a 50-bps move.
  • The overall tone will in our view remain very hawkish considering the latest inflation figures and the downward pressure on the exchange rate.
  • We also expect President Lagarde to reiterate that the pace of policy tightening will be guided by optionality, data-dependence, gradualism, and flexibility. She will confirm that the key ECB interest rates will rise again in September, with the calibration of this rate increase depending on the updated medium-term inflation outlook. 
  • She will likely reaffirm the ECB’s very strong commitment to act against unwarranted fragmentation. The ECB will also provide more details about the so called “Transmission Protection Mechanism”, its new bond-buying program. We expect this plan to be unlimited, with light conditionalities and 100% sterilized. It will be a difficult exercise in communications for the ECB, with a lot of questions around this new plan: what does “light conditionality mean exactly? What are the “right” circumstances under which the tool could be deployed? Is the ECB going to favor specific parts of the curve?
  • We also expect the ECB to confirm discussions to modify TLTRO (Targeted longer-term refinancing operations) III eligibility requirements given the accelerated pace of monetary policy normalization.

All in all, the main risk would be to see the ECB fall short of market expectations regarding the new plan. The ECB has a difficult exercise in communications, especially given new political turmoil in Italy. Ahead of this meeting, we remain cautious on peripheral bond spreads, and we still see a potential for more flattening across European curves.

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