ECB meeting on Thursday, June 9, 2022

This Thursday’s meeting will be an important communication exercise to provide more specific forward-looking guidance on which rates to change.

By Eric Mueller, Director of Product and Investment Strategy

Eric Mueller

President Lagarde’s blog, published on May 23, has effectively completed a series of discussions in the Board of Governors on how to get out of negative interest rates as soon as possible. As a result of this blog, forward interest rates were raised to estimate the 130 basis points of the ECB’s increase by the end of this year. For President Lagarde, consistency has always been important. Therefore, we can expect that the meeting will officially announce the completion of the asset purchase program (APP) in the first days of July. This will remain a few weeks before the meeting on July 21, where the first rate increase by 25 basis points is to take place. We also expect President Lagarde to make it clear that this first increase will be immediately followed by another at the September meeting.

Philip Lane’s latest speech seems to explain that the “gradual” increase in interest rates refers to a quarterly increase. However, we believe that there is a significant risk of negative surprises in terms of inflation in the coming months and that faster growth may be justified. The choice will be to continue the quarterly sequence with a step of 50 bp as an option or to accelerate with movements of 25 bp in the “intermediate” meetings. In our opinion, at the meetings in July, September, October and December, four increases of 25 basis points are expected in response to the continuation of high inflation and a slight decrease in medium-term inflation expectations. This phenomenon is seen in the SPF (Professional Forecasters ‘Survey) and the SMA (Monetary Analysts’ Survey) and is a real source of concern for the ECB. We also expect further rates to rise in 2023, and the DFR (Deposit Rate) is expected to reach at least 1.5% in the fourth quarter of next year.

There was no specific clear mention of what a neutral rate could be and whether it would be necessary to go beyond it. At this stage, it is certainly very difficult to know where the strain will end next year with such great uncertainty, but we believe that the risk of underestimating the inflation plateau remains very high for at least the next two quarters. Anecdotal evidence suggests that in addition to well-known supply constraints in the commodity, energy, and some food prices sectors, there is an unexpected effect when even services or producers do not directly influence price increases to take advantage of the general trend.

So far, ECB members have not provided details on how to curb possible financial fragmentation that would result from the rapid rise in interest rates amid slowing macroeconomic dynamics. President Lagarde referred to past experience when new tools were created that were effective when needed. This is unlikely to satisfy markets that want to hear more about what is possible and how such a new instrument will be compatible with the reduction in excess liquidity that begins in June with large early repayments of long-term target refinancing (TLTRO). This should attract the attention of markets, as peripheral spreads are expanding and package profitability has risen by 35 basis points since its May 23 blog post by President Lagarde.

The change in the ECB’s position on the need for a quick exit from negative interest rates, as well as the apparent consensus behind this decision, immediately helped the euro find a minimum value against the dollar, which should reassure hawks who were clearly (and rightly) concerned about the 8% fall against the dollar from January 2022 to mid-May 2022. The firm tone at the press conference on the determination to return inflation close to the medium-term goal and the somewhat encouraging performance of the eurozone manufacturing sector should consolidate the euro above recent lows in the coming months.

This material is not intended to be used as a forecast, research or investment advice, and is not a recommendation, offer or call to buy or sell securities or adopt any investment strategy. The views expressed by Muzinich & Co are effective as of June 2022 and are subject to change without notice.