• Given that the ECB has announced that it will keep full allotment in place at its weekly main refinancing operations and at its 1-month auctions until October we think that a hike in November 2010 is too early and we thus move our projection of a first hike to Q1 2011.

The ECB is heading towards the exit at a slow pace

The ECB announced last Thursday at the ECB Governing Council meeting that the 3-month auctions will be with fixed allotment from now on (see ECB meeting: A slow normalisation). The ECB also announced that the weekly main refinancing operations and the 1-month auctions will continue to be with full allotment at least until 12 October 2010. We expect that the ECB will move to fixed allotment at the 1-month auctions in October and for the main refinancing rates at end-2010 at the latest (most likely in October too).

Although the ECB has emphasised that it can hike rates before the non-standard measures have been withdrawn, we do not expect that to happen. Such a move would in theory make sense if the real economy had healed so much that a hike is warranted while the financial markets would still need to be supported by unlimited liquidity.

A removal of full allotment in October means that short market rates will most likely increase sharply in October, which will have an impact similar to a 50bp rate hike. A hike in November 2010 as we expected previously would then imply an unusually sharp increase in short market rates.

Looking at the economic analysis the ECB still expects a very slow economic recovery and low inflationary pressures. Inflation in both 2010 and 2011 is projected to be well below the ECB’s inflation target.

In addition, the monetary analysis is not sending any signals that the ECB needs to “lean against the wind” and hike rates.

We thus move our projection of a first hike to Q1 2011.

There will be headwinds from substantial fiscal tightening in most Euroland countries in 2011. We therefore expect that the ECB will hike the refinancing rate at a slow pace (by 0.25%-point every third month) bringing the refinancing rate to 2.0% at end 2011.