The ECB is set to slow the pace of rate hikes, matching the Fed's 25-bp move yesterday and taking the key rate to 3.25%, after its preferred inflation measure eased for the first time in 10 months.
Front-end German yields and euro-area swap rates have declined in the run-up to the European Central Bank’s policy review, reflecting skepticism that the monetary authority will be able to persist with its tightening for long. With inflation still running rife, the ECB is likely to push back against such conviction.
Size of hike:
Interest-rate traders have fully priced a 25-basis point increase and are assigning only a 16% chance of a bigger move. Considering the dovish language from the Federal Reserve overnight, the ECB may be willing to slow the pace after three successive 50-basis point moves through March. President Christine Lagarde’s recent remarks suggest as much, with “a little way” failing to convey a sense that another bigger move is needed:
“There’s still a little way to go on the path. The length of the path will depend on a number of factors, notably the impact on credit from the financial troubles we saw.”
If the ECB’s statement states explicitly that further tightening may be needed, that would suggest a strong hawkish divergence of views within the governing council. Two-year euro area swap rates have declined about 50 basis points from this year’s peak to 3.45%, and any hawkish intent has the potential to send the rate toward 3.70% in the coming months.
Path Ahead:
Traders have, for some time now, been pricing in a terminal rate of around 3.75%, which hasn’t seen much of a pushback from ECB officials. In fact, governing council member Klaas Knot recently acknowledged the markets’ calculus by remarking that he’s “not uncomfortable” with such pricing.
Even at 3.75%, the ECB’s real policy rate will be deeply negative given that it expects inflation to converge to 5.3% this year. That would mean the central bank may be emboldened to guide the markets toward a higher trajectory. Unlike the Fed on Wednesday, it won’t convey the message that it’s in a “one and done” mode.
Asset Portfolio:
The ECB’s asset-purchase portfolio is on track to decline at a pace of EUR15 billion per month on average this quarter, with an increase in the roll-off
