ECB: Follows Guidance with 50bps Hike, Switches to Wait-and-See Stance 

• The ECB followed through on its long-communicated guidance with a 50bps hike today, but accompanied this with very limited signaling regarding the future policy path, against a backdrop of financial stability concerns.

• For now, if markets and the economy get past current turbulence somewhat successfully, the ECB looks set to hike 25bps at its next meeting (and likely the one after that) with a chance it shifts to a faster QT in the second half of 2023.

• Lagarde said that if their baseline persists, then the ECB will still have “a lot more ground to cover”—with the caveat of higher uncertainty in this baseline. The baseline persisting should provide solid support to the EUR and EGB yields , but it may be too early to call.

The ECB followed through on its long-communicated guidance with a 50bps hike today, but accompanied this with very limited signaling regarding the future policy path, against a backdrop of financial stability concerns. Had this meeting taken place just one week ago, the bank may have sounded a more hawkish note given today’s revision higher to its core inflation and GDP growth forecasts (table 1).

With the statement and Lagarde’s presser giving us little to go on in terms of what to expect at the May decision, we leave our forecast unchanged, seeing a 25bps hike at the May meeting.

The EUR initially rallied slightly alongside a jump in European yields given the 34bps priced in ahead of the announcement (i.e. a higher chance of a 25bps increase, chart 1 for recent moves). But, the half-point hike seemingly soured the global mood in markets that had even braced for a 25bps move after a ‘dovish’ leak to Bloomberg: de Guindos noting on Tuesday, behind closed doors, that some EU banks may be vulnerable to higher rates. Markets have recovered over the past hour or so (SPX is 1% higher on the day), thanks to reports that large US banks are in talks to support First Republic. 

Still, the 15bps or so range in German 2-yr yields since the leak and around and following the statement is relatively narrow when compared to recent market action (chart 2). From the shortly-lived peak on the announcement, the 2yr fell as much as 15bps before a drive higher from US yields on bank news helped them higher to sit at their highest point since before the de Guindos story—at about 2.55% at writing. The spread between German and US 2yr yields has widened by about 20bps since Lagarde finished her presser, however, as European banking risks seem to outweigh those in the US. At writing, the EUR is roughly unchanged on the day just around 1.06 after falling as low as 1.0551 about two hours ago.

It may simply be that case that the EUR and EGBs will remain bound by the evolving situation around Europe’s financial sector (and the US) and it will become clear what the next ECB step will be in due time. For now, if markets and the economy get past current turbulence somewhat successfully, the ECB looks set to hike 25bps at its next meeting (and likely the one after that) with a chance it shifts to a faster QT in the second half of 2023. The fact that hikes look relatively underpriced in markets (chart 1) should be supportive for the EUR as (if) things normalize.

According to Lagarde, the 50bps hike was the only option presented and a “very large majority” backed this choice, with “three or four” preferring to wait to see how the situation unfolds (though not opposing in “in principle”). That looks like strong enough support for today’s hike all things considered.

The complete set of communications seems like a fair compromise given elevated uncertainty; the ECB didn’t give too much away, understandably. The bank has given itself optionality and time to respond to data and see how the situation shakes out, while not feeding the panic in markets with a dovish message or evidence of alarm among the Governing Council. Sticking to the hike that they had teed up is also less of a surprise and allows them to press on with the inflation fight on the hope that the situation resolves itself without too much impact on lending (and thus the economy). Do note that the lower headline inflation forecast (table 1 and chart 3), which sees it steeply falling over the next few months, could act to check the bank’s hawkishness.

The statement, as well as Lagarde and de Guindos at the presser, highlighted the resilience of the banking sector. The ECB has is now clearly in a wait-and-see stance regarding financial risks, but the statement now includes an important mention that the ECB “is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.” This may implicitly suggest that the bank will put out fires in banking with its facilities while it continues to hike in line with its inflation goal—particularly its expectation of higher core inflation this year. Lagarde also said that if their baseline persists, then the ECB will still have “a lot more ground to cover”—with the caveat of higher uncertainty in this baseline.

Though the Eurozone economy looks fairly detached from the failure of banks in the US—caused mainly by idiosyncratic rather than systemic challenges—the ECB does not yet have enough information on the possible repercussions of the events in the past few days relating to Credit Suisse to confidently tee up it s next move. Even prior to the recent troubles in the financial sector, the ECB had reason to stick a data dependent approach with inflation on a decelerating path and a falling inflation expectations.