ECB Remains Hawkish

A 50bps hike after two previous meetings of 75bps hike

• Prior to the ECB’s policy meeting, our focus was on (1) if ECB opts for a 75bps rate hike with a dovish message or (2) a 50bps rate hike with a hawkish message.

• The message was clear. The ECB opted for the latter with a 50bps rate hike to 2.00% and accompanied by a hawkish message. It comes about after 75bps hike in their two previous meetings. The slower pace of rate hike could be attributed to some signs of price pressures easing and a recession loom.

A More Hawkish Tone

• We found the following tone from the ECB in the latest policy meeting to be hawkish. The central bank cited “interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2.0% medium-term target”.

• And ECB further said, “keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift”.

QT From March 2023

• The central bank also announced it would start to reduce its bond portfolio — quantitative tightening (QT) from March 2023 onwards.

• ECB’s bond holdings reduction, the reinvestments of maturing bonds under the asset purchase programme (APP) portfolio will decline to EUR15bn per month on average until the end of the 2Q23 “and Its Subsequent Pace Will be Determined Over Time”.

A Short Lived and Shallow Recession

• Meanwhile, the ECB expects only a short and shallow recession. The central bank forecast eurozone growth to come in at 0.5% in 2023 and 1.9% in 2024.

• We feel it is far more optimistic than our own growth forecast of - 0.2% and 1.5% in 2023 and 2024 respectively.

• And ECB is also expecting inflation to come down to 3.4% in 2024 and 2.3% in 2025. The 2024 number was revised upwards significantly. This justifies for more rate hikes in the future.

Very Little ECB Can Do

• We conclude that ECB is combating in two key areas — (1) addressing the high inflation and (2) ensuring its credibility and reputation.

• And we still feel there is very little the ECB can do to bring down inflation. What we believe is that central bank may be able to address inflation expectations.

• Following today’s hawkish tone with smaller rate hike, we are of the view that the central bank will use the interest rates to address inflation. We expect another 50bps hike in 1H23 to bring the policy rate to settle at 3.00%. Balance sheet reduction will stay at the backseat.

• And our concern remains that ECB could push the eurozone economy further into recession with every new rate hike. We remain sceptical on their relatively optimistic growth outlook.

Source: AmInvest Research - 16 Dec 2022