ECB Hikes 50bps As Expected, Issues Dovish Forward Guidance, Unveils Climate QE

In a mirror image of the dovish BOE earlier this morning, which hiked 50bps but signaled that its tightening cycle may well be over sending sterling and gilt yields sliding, moments ago the ECB, which continues to believe erroneously that if only it can crash the European economy it will somehow have control over Russian commodity prices, hiked interest rates by 50bps, as expected.

We raised interest rates by 0.5 percentage points.

See our latest monetary policy decisions https://t.co/m4C5jKNH0j pic.twitter.com/EopgGBQEcE

— European Central Bank (@ecb) February 2, 2023

Also in a dovish twist of forward guidance, the central bank also said intends to hike another 50bps in March, and only then will it “evaluate the subsequent path of its monetary policy.” This is actually dovish because in December’s press conference Lagarde flagged that we could see as many as three more 50bp hikes… not any more. Here is the statement:

“In view of the underlying inflation pressures, the Governing Council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy. 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 in inflation expectations. In any event, the Governing Council’s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.”

Compare this to December, when the ECB expected “to raise [rates] significantly further, because inflation remains far too high and is projected to stay above the target for too long”. It also said that “rates will still have to rise significantly at a steady pace” and future decisions will “be data-dependent and follow a meeting-by-meeting approach ” In December its outlook was “euro area economy may contract in the current quarter and the next quarter, owing to the energy crisis, high uncertainty, weakening global economic activity and tighter financing conditions.” adding that “a recession would be relatively short-lived and shallow ” Ahead “growth [was] projected to recover as the current headwinds fade.”

Breaking down the statement, let’s look at Guidance first:

• Governing Council judges that 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% medium-term target
• The Governing Council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy.
• Governing Council’s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach

… and QT (as a reminder, in December, the APP portfolio will decline by €15 billion per month on average from the beginning of March until the end of June 2023, and the subsequent pace of portfolio reduction will be determined over time):

• Remaining reinvestment amounts will be allocated proportionally to the share of redemptions across each constituent programme of the APP and, under the public sector purchase programme (PSPP), to the share of redemptions of each jurisdiction and across national and supranational issuers.
• In particular, the remaining reinvestments will be tilted more strongly towards issuers with a better climate performance. Without prejudice to the ECB’s price stability objective, this approach will support the gradual decarbonisation of the Eurosystem’s corporate bond holdings, in line with the goals of the Paris Agreement.

And while it is of secondary important, the most hilarious part in the statement was the ECB’s disclosure of what can only be dubbed Climate QE, to wit:

For the Eurosystem’s corporate bond purchases, the remaining reinvestments will be tilted more strongly towards issuers with a better climate performance. Without prejudice to the ECB’s price stability objective, this approach will support the gradual decarbonisation of the Eurosystem’s corporate bond holdings, in line with the goals of the Paris Agreement.

Yup: just when you thought the idiots in charge of the ECB couldn’t shock us any more, they go ahead and totally redeem themselves.

What happened next?

Well, in wake of the ECB policy announcement, where a 50bp hike was delivered as expected, a marked dovish reaction has been seen given the dialling down of the hawkish language from December. In December’s press conference Lagarde flagged that we could see as many as three more 50bp hike (i.e the February. March and May meetings): however in the February statement the language has now been altered to guide participants towards a 50bp hike in March and thereafter the ECB will “evaluate the subsequent path of its monetary policy.”

Looking at market, the Mar 2023 bund spiked from 137.91 to an eventual session peak of 138.62 with the accompanying 10yr yield dropping from 2.21% to 2.15%. Given the pronounced EGB move, USTs and Gilts have also rallied with USTs at a fresh session high of 115.25.

In FX, the EUR/USD also came under immediate pressure falling from 1.0988 to 1.0961. before trimming back around half of the move as we await further commentary and guidance from President Lagarde and any fresh insights into the ongoing debate between the ECB’s hawks and doves, particularly on core inflation and the possibility for a step-down from 50bp increments to 25bp at a post-March meeting.