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EUR: A new kind of central bank dependency
The ECB defied some dovish speculation and hiked by 50bp yesterday. The move appeared appropriate not just from an inflation-battling and credibility perspective but also given a pause might have sent a signal of mistrust to a market that is nervously assessing the contagion risk of the US and Swiss banking troubles. That said, it created a whole new set of communication issues for President Lagarde and her colleagues.
The heightened uncertainty related to financial market instability was - by Lagarde’s own admission – a great incentive to abandon any trace of forward guidance in favour of a full data-dependent approach. This, in practice, means that the ECB is now both data-dependent and financial-stability-dependent. Lagarde clarified there is no trade-off between price stability and financial stability, although one could argue this is exactly what we are witnessing right now, considering how much the ECB and Fed narrative has changed in only a week: e.g. 3-4 members of the Governing Council actually wanted to keep rates on hold yesterday. The message, however, was clear: the focus remains on inflation. At the same time, one “hope” could be that instability in the financial sector does some of the monetary tightening itself, ultimately offering an economic reason to slow tightening. For now, our economists' base case is still two more 25bp hikes by the ECB.
EUR/USD traded slightly lower after the ECB announcement, probably due to the adverse reaction in European bank stocks. The EUR-USD 2-year swap rate dropped yesterday, both as markets saw the ECB data-dependent approach as dovish and because a Fed rate hike was being priced back in. Short-term rate spreads are, however, a very marginal driver for EUR/USD (as discussed here from a statistical standpoint), especially when compared to equity dynamics. A de-escalation in the tension within the financial sector and stabilisation in sentiment continue to constitute the clearest pattern for a EUR/USD rally from the current levels.
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Today, keep an eye on the announcement of the amount repaid by banks under the ECB TLTROs. It is looking increasingly likely that we could see smaller repayments as banks try to retain more liquidity as a precautionary measure. On the data side, there is the final read of the euro area inflation for February and the OECD interim Economic Outlook projections to watch for. We’ll also continue to hear post-ECB comments from governing council members. This morning, Madis Muller made the first remarks after the announcement, saying that the inflation forecasts imply more hikes.
Francesco Pesole
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