By William Watts
European Central Bank President Christine Lagarde on Thursday attempted to push back against rising market expectations for policy interest rate increases by the end of next year, saying that such a move wasn’t in line with the bank’s detailed road map to liftoff.
“Our analysis certainly does not support that the conditions of our forward guidance are satisfied at the time of liftoff as expected by markets not any time soon thereafter,” Lagarde said at a news conference after the ECB Governing Council, as expected, left its monetary policy settings unchanged.
But market participants appeared to pay little attention, with the euro gaining versus rivals, short-dated eurozone government bond yields adding to gains and December 2022 and December 2023 Euribor futures collapsing as investors continued to price in rate increases.
The more Lagarde insisted the market had the rate outlook wrong, “the more the market thumbs its nose,” tweeted John J. Hardy, head of FX strategy at Saxo Bank A/S.
But Lagarde “couldn’t have been much clearer in pushing back hard against the recent pulling forward of market expectations for ECB lift-off, reiterating the message that inflation should ease over the course of 2022,” said Seema Shah, chief strategist at Principal Global Investors, in emailed comments.
So what gives? The easy way to solve the disconnect between the market reaction and Lagarde’s remarks is that traders “simply don’t believe the ECB’s view on inflation, nor for that matter the view taken by the consensus,” said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, in a note.
“That’s fine, and we are always wary discounting a sustained and powerful signal from bond markets. On this occasion, however, we’re sticking to our view that the current path for [eurozone] rates implied by short-term rate expectations is much too steep,” he wrote.
Lagarde also said it wasn’t for her to say whether markets were getting ahead of themselves in pricing in rate increases, a remark that some analysts saw as diluting the impact of her insistence that market expectations weren’t in line with the ECB’s forward guidance.
Lagarde said policy makers discussed “inflation, inflation, inflation” in their meeting on Wednesday and Thursday, but reiterated expectations that supply bottlenecks and rising pressures from energy prices and other factors will fade over the course of next year, though they are proving more persistent than initially expected.
Some ECB watchers saw the emphasis on inflation as a tacit admission that price pressures may not prove “transitory,” after Lagarde noted expectations wages will rise and the ECB scrapped a sentence in the opening statement noting that measures of long-term inflation expectations “remain some distance” from the bank’s 2% target.
The ECB “is clearly crawling back from its fully convinced view of inflation being transitory,” said Carsten Brzeski, global head of macro at ING, in a note.
Brzeski said the ECB appears to be setting the stage for a move toward a tapering of its monetary policy support at its December meeting.
The ECB “is in no rush to tighten monetary policy as it still sticks to the view that the current episode of too high inflation is only temporary,” he said. “However, the view that the costs of being behind the curve are much lower than the costs of the premature normalization of monetary policy seems to stand on less solid feet than a few months ago.”
The ECB, as expected, left its monetary policy measures unchanged. In its policy statement, the ECB said the Governing Council agreed to continue asset purchases under the pandemic emergency purchase program, or PEPP, at a some what slower pace than seen in the second and third quarters. The ECB moved in September to slow the rate of PEPP purchases.
Other measures, including interest rates, were also left unchanged. Purchases under the separate Asset Purchase Program will continue at a pace of 20 billion euros ($23.2 billion) a month.
The ECB also reiterated its guidance on future rate moves, saying it expects key ECB interest rates “to remain at their present or lower levels until it sees inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon, and it judges that realized progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilizing at 2% over the medium term.”
Lagarde said it remained to be determined whether the ECB would fully use the 1.85 trillion euro envelope available for PEPP purchases, but said she currently expects the program to end in March. Nor did the Governing Council address whether it will beef up the Asset Purchase Program when the PEPP comes to an end, she said.
ECB watchers see the central bank facing a tough decision in December, when it will be under pressure to decide when and how to begin winding down the PEPP purchases.
The market moves come amid a selloff in short-term government debt around the world that has driven up yields and flattened yield curves.
Investors were also weighing U.S. data, including a sharper-than-expected slowdown in third-quarter gross domestic product growth.
The euro /zigman2/quotes/210561242/realtime/sampled EURUSD +0.9635% was was up 0.6% versus the U.S. dollar at $1.1679, while the Stoxx Europe 600 edged up 0.1%. The yield on the 10-year German government bond /zigman2/quotes/211347112/realtime BX:TMBMKDE-10Y -34.26% rose 5 basis points to negative 0.125%. The yield premium demanded by investors to hold the 10-year Italian government bond /zigman2/quotes/211347230/realtime BX:TMBMKIT-10Y -9.23% over its German counterpart jumped nearly to more than 119 basis points, or 1.19 percentage point, a rise of 7 basis points, to its highest since May.