Holding Pattern: ECB's Dovish Stance Sets the Tone Amidst Global Rate Uncertainty

Rates Spark: We’re now in a holding pattern

The ECB keeping rates on hold reflects what will likely be a common theme at next week's Fed and BoE meetings, and its dovish tone will find affirmation in upcoming inflation and growth data. But longer-end rates remain under the spell of US Treasuries, where supply is also a key driver.

 

The ECB delivers a dovish hold

The European Central Bank kept interest rates on hold as widely anticipated but struck a slightly more dovish tone than expected. Importantly, the ECB refrained from shifting the focus to the balance sheet now rates are deemed sufficiently high. According to President Christine Lagarde, both the PEPP and the minimum reserve requirement were not even discussed.  

Lagarde highlighted again that data dependency also means rate hikes could not be excluded, but she said any discussion about cuts was “totally premature”. That said, the undertone regarding the economy has become more cautious. Also, with regard to a potential spike in energy prices, she highlighted the uncertainty of their medium-term impact on inflation.

Overall, market reaction in outright rates is more difficult to disentangle given the release of US data just ahead of the press conference. Very front-end rates, which should be less influenced by US spillovers, reflected the somewhat more dovish take and a firming notion that the ECB has reached peak rates already. The already minimal hike speculation reflected in ECB-dated OIS forwards for December was further trimmed, and the strip is downward sloping from then onwards to fully discount a rate cut by June next year.   

Sovereign spreads initially reacted with relief, with the key spread of 10Y Italian government bonds versus Bunds briefly narrowing back below 200bp. Obviously, it is unlikely to be the end of the story, and the ECB could pick up the discussion at some point. Indeed, Reuters later reported that policymakers agreed to postpone the debate until the winter. and a discussion on minimum reserves was reported to come as part of the operational framework review.