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Market Update - ECB presses on with 25bps hike but has not reached the destination

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Market Update - ECB presses on with 25bps hike but has not reached the destination

Jun 16, 2023

  • The ECB hiked policy rates by 25bps bringing the deposit rate to 3.50 per cent and confirming the rather explicit guidance of ECB President Lagarde that “there is more ground to cover.” This is the eighth consecutive hike in rates, which has brought the key policy rate to its highest level in 22 years
  • Ms Lagarde clearly stated that “we are not at the destination,” and therefore, a 25bps hike in July seems almost inevitable. The meeting-by-meeting and data-dependent approach that was reiterated, allowed the governing council to side-step any further firm commitments beyond this point. However, the likelihood of a further rate hike to 4.0 per cent in September has now increased, given that policymakers highlighted that “we have not considered pausing.” 
  • With GDP forecasts broadly unchanged and inflation expectations revised marginally upward, the ECB’s assessment that inflation is expected to remain too high for too long lends support to our view that two additional hikes will be required in order to achieve a sufficiently restrictive level
  • The end of reinvestments in the asset purchasing programme (APP) was confirmed for July, and market participants will eagerly await the upcoming redemption of Targeted longer-term refinancing operations (TLTRO) loans on 28th June to assess any impact on liquidity
  • European markets started the day in the red as they digested the Fed’s “hawkish pause” (A hawkish pause?) and prepared for a hawkish message from the ECB as well. The release of the decision pushed markets even lower, but equity markets retraced most of the day’s losses at the time of writing. Policy-sensitive 2-year yields were up almost 10bps on the day for Germany, Spain, and Italy, although longer-dated yields rose by a smaller amount. The futures market is now pricing in 48bps of additional hikes by October, suggesting that the ECB will deliver two more hikes
  • The ECB’s hawkish outlook on inflation and the fact that neither a pause nor future cuts are being discussed at this stage suggests that interest rate differentials will increasingly favour the EUR in the coming months. The EUR broke through 1.09 for the first time since mid-May and should end the year even higher. With bond yields back towards the highs of recent trading ranges, we continue to see value in high-quality investment-grade bonds

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