The ECB is juggling the fragmentation of the eurozone

Disappointed or not? The gap between the Italian and German 10-year BTP-Bund rates, which many see as a measure of financial fragmentation in the eurozone, jumped 22 basis points (bps), from 206 to 228 basis points, following the publication of the European Central Bank (ECB) monetary policy. The board of directors, which we knew in advance would announce on Thursday the completion of the regular asset purchase program (APP) in late June – after the emergency procurement program (PEPP) in late March – had a choice between two paths for the future. Despite a strongly restrictive (“hawk” or “hawk”) discourse on inflation, Christine Lagarde could not find a clear choice between a gradual rate hike and a rapid rate hike accompanied by anti-fragmentation.

The President announced that the ECB will raise the key rate by 25 bp. July 21 on a “significant” but “not excessive” and “indicative” to begin the “long journey” of normalization. It will resume this movement on September 8 with an increase of 50 bp, (if the medium-term inflation forecast is maintained or worsened, for example, if inflation forecasts for the year N + 2 (according to the formula “forward orientation”)) are still above 2% ». These decisions put an end to the era of negative betting, which began in June 2014.

Most analysts combined the first two increases by 25 and 50 basis points, and “in this context, the spread of profitability was inevitable and, however, quite controlled,” said Antoine Bouvet, ING’s rate strategist. As with swap markets, Michel Martinez, chief European economist at Societe Generale CIB, is now seeing a steady increase of 25, 50, 50 and 25 basis points this year.

Optimistic forecasts?

These announcements are based on new economic forecasts for the eurozone, but “the reaction of the markets seemed stronger than expected, due to lower inflation, announced above the target, despite strong measures,” – said Patrice Guthrie, chief economist at UBP. . His colleagues at the ECB now expect annual inflation of 6.8% in 2022 (instead of 5.1% in March) with core inflation of 3.3%, 3.5% in 2023 (instead of 2.1%) and 2 , 1% in 2024 (instead of 1.9%). It is also expected to grow by 2.8% in 2022 (instead of 3.7% in March), then 2.1% in 2023 (instead of 2.8%) and 2.1% in 2024 (instead of 1.6%) ). “We are likely to have 2% to 2.5% growth in 2022 and 1.5% to 2% in 2023 after growth growth is erased,” said Patrice Gottrieb. “The long-term inflation forecast of over 2% is unprecedented and reflects major changes,” said Nicholas Forest, head of Candriam’s bond management, for whom “starting the normalization process at this stage of the cycle remains a real challenge.”

However, the ECB figures are in line with the consensus: + 6.8% inflation and + 2.7% GDP in 2022. “Since December 2022, growth has held up amid inflationary shocks, and the recovery of many sectors, such as tourism, can be seen through high-frequency indicators, should extend the good surprise of the first quarter to at least the next two. Not to mention the congestion that may arise from China, “said Michel Martinez. “Annual data on household incomes with rising wages, bonuses and return to work for those stuck with Covid restrictions in 2021 are also very positive, in the first quarter in France + 6.9% yoy in the first quarter. With the expansion of the budget, all this does not mean, except for the aggravation of the crisis in Ukraine, a recession in the short term, “he added, supporting the estimates of the ECB, which has not yet seen the beginning of the inflationary spiral over wages. .

Intervention threshold to be checked

The economic situation has returned to the “hawks” governors. “Markets no doubt regretted not having information on a hypothetical anti-fragmentation tool,” said Patrice Gottrieb. However, the ECB cannot provide too much information on such an instrument, as it is subject to many regulatory constraints. “And because it would make it possible to assess the threshold of intervention that markets are trying to test,” adds Michel Martinez. We do not think that the ECB will give any “ex ante” or even that it will create such an instrument without a major crisis. It is currently focused on inflation, and it is easier to raise rates higher in the first stage to slow growth later by checking the neutral rate, which is probably somewhere between 1% and 2%.

During a press conference, Christine Lagarde mentioned less use of non-traditional means. The base rate of -1% (instead of -0.50% for the deposit rate) on long-term refinancing operations (TLTRO 3) will end on June 23, which should limit interest rates and participate in reducing the ECB’s balance sheet by mid-2023. While “PEPP reinvestment by the end of 2024 may not be enough to combat fragmentation in the eurozone,” for Antoine Bouvet, she insisted on a vague reformulation of the conditions for reinvesting APP, which could also worry markets.

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