The ECB delivered a large 75bp rate hike on Thursday, taking the main refinance rate to 1.25% and deposit facility rate to 0.75%, marking the single largest hike on record for the bloc. The two-tier system was suspended, and multiplier set to zero. Policy guidance was hawkish as inflation risks were seen as becoming broad-based, and the ECB sees the need to hike interest rates ‘several times’ in the coming months. This was balanced by remarks that a) hikes were being frontloaded; b) risks of a growth slowdown; and c) forward guidance stuck to a ‘meeting to meeting’ approach.
Data projections backed the cautious view on inflation, with 2022’s seen at 8.1% YoY (vs 6.8% earlier), 2023 at 5.5% (vs 3.5%), easing towards the target in 2024 at 2.3% (vs 2.1%). While base effects were behind the counter intuitive move of an upward revision in 2022 growth numbers, 2023 was taken sharply lower to 0.9% (vs 2.1%), with stagnation expected to set in 1Q23, just as high energy prices exert an additional tax on purchasing power.
As hawks take the driver’s seat at the ECB, this rate hike cycle is likely to settle at the higher end of the 1.5-2.0% range, rather that 1.0-1.5% we assumed earlier. With the inflation target at 2%, the terminal rate will still be far below restrictive levels. Impending slowdown in the Eurozone growth in late-2022 and early-2023 will, therefore, be more on account of geopolitics and impending energy crisis rather than the tightening cycle. On markets, the jumbo rate hike provided brief support to the euro, which was offset by subsequent hawkish talk by the US Fed. German bond yields ticked up, as did Italian rates on the central bank’s hawkish rhetoric, with the TPI tool (Transmission Protection Instrument) positioned as a deterrent to sharp rises in borrowing costs of member countries.
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