Market Wire - Surprisingly Hawkish ECB Lifts Euro
Karthik Sankaran - Senior Market Strategist, firstname.lastname@example.org
At its meeting today, the European Central Bank surprised markets that had expected a dovish response to the Ukraine war by opening the possibility that it would end quantitative easing in the third quarter of 2022 “if the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of …net asset purchases.”
At the same time, the central bank altered its language on timing by saying “Any adjustments to the key ECB interest rates will take place “some time after” [a change from “shortly after” in the last statement] the end of the Governing Council’s net purchases.
The euro rallied after the decision. Two-year Bund yields climbed from -50 basis points to -38 basis points, and traders began to price in one full 25 basis point rate hike by the end of October, with 40 basis points in tightening expected by year end.
Market expectations moves have been volatile all year. The meeting on February 3 called for a reduced rate of asset purchases at 20 billion euros a month for “as long as necessary.”. However, the surprisingly-hawkish tone of President Lagarde’s conference and other policymakers speakers shifted market expectations to an earlier end of asset purchases and a first hike in late 2022, before the war led market expectations in a dovish direction again.
The ECB has repeatedly said that it would use reinvestments from its Pandemic Emergency Purchase Program, which is not formally subject to the need to purchase national government bonds in proportion to its capital key, to smooth any turbulence in intra-Eurozone bond spreads. Nevertheless, the decision did lead to a sharp selloff in Italian government debt, with 10-year Italian bond yields rising by 20 basis points after the meeting, versus only a 6 basis-point rise in German yields. Beyond the euro and short-term interest rates, traders are likely to keep watching the behaviour of Italian bonds as an indicator of stresses within the Eurozone.