September 15, 2022
  • September 15, 2022

ECB Snapshot – Inflation forces normalization process to continue

By on March 6, 2022 0
  • A tough ECB meeting is due to take place on Thursday next week. After the crucial shift in hawkish communication at the February meeting, the ECB will have to balance a stronger inflation outlook against the highly uncertain economic impact of the war between Ukraine and Russia.
  • We expect the ECB to continue its trajectory towards a “neutral” monetary policy calibration and formally set an end date for the APP program (September this year), due to strong inflationary pressure, but do not give not a firm indication of an upcoming rate hike. We expect the ECB to remove the “or less” wording from forward rate guidance and give no indication of time between the end of the APP and the first rate hike, removing “shortly before” from his statement of decision.
  • Staff projections are likely to contain exceptional uncertainties as the implications of the war between Ukraine and Russia are not yet known. We expect staff projections to point to 2% underlying inflation in 2023 and 2024, allowing the process of policy normalization to continue.
  • We recognize that there is a risk that our view of the expected ‘further normalization’ process will only occur at a later stage, as it could be a politically difficult decision to tighten monetary policy with a war on the continent. However, we expect strong underlying inflationary pressure to prevail in the discussion (especially after February core inflation of 2.7%y/y, 0.4%m/m sa), despite weaker growth prospects.
  • The ECB is attentive to financial stability and could launch a 1-year LTRO operation as early as March 2022. We expect a formal end to the TLTRO haircut to be set for June 2022, as widely expected.
  • We think the markets might get a hawkish surprise at first, but for now, we think the 27bps priced upside in December this year is fair from a risk/reward perspective.

Resilient economic context with uncertainty due to the war…

Russia’s aggression in Ukraine is an unpleasant source of uncertainty for a central bank and especially after the ECB’s hawkish pivot at the February meeting, clearly raising expectations for further policy tightening. The stronger than expected economic backdrop and tight labor markets with elevated and more persistent inflationary pressures should – all things being equal – make the ECB quite confident in the need for a gradual and flexible approach to normalization monetary policy. However, emphasizing a strong data-dependent position with optionality will remain crucial in our view.

…but high inflation to keep pressure on the ECB to start exiting monetary policy

It will be a difficult communication exercise awaiting the ECB at the March meeting. The economy rebounded at the start of the year as the disappearance of headwinds from Omicron and the easing of supply chain tensions supported services and manufacturing activity. The labor market recovery also continued at a rapid pace, with the unemployment rate falling to a new all-time low of 6.8% in January and the labor force participation rate rising above pre-crisis levels.

Full report in PDF.