ECB: Inflation uncertainty and data dependency

The Fed meeting this week has turned the ECB meeting on Thursday next week much more interesting than anticipated from a market perspective. While we do not expect the meeting to bring significant new signals to the market, attention to the elevated inflation and even more data dependence, as well as the difference to Fed, will be in focus.

Since the December meeting, where ECB communicated its planned monetary policy calibration until October 2022, no data release has warranted a change in stance. We expect ECB to convey a robust, yet slowing, economic outlook and an elevated uncertainty on the inflation outlook with a confirmation of inflation expected to settle below the 2% target towards the end of the year and in 2023 and 2024.

We expect attention to the recent rise in real rates, but given the absolute level of the metric, we do not believe this would give cause for concern at the ECB.

We do not see ECB giving indications to follow the other major central banks in their tightening cycle. To us, it would be a surprise if ECB were to announce new TLTRO rounds at the meeting next week. We continue to expect tiering multiplier to be increased to 12 later in the year (most likely in June).

From a near-term market reaction perspective, we remain unconvinced whether markets will buy into the ECB’s wait-and-see stance and keep the very aggressive front end pricing for Dec22 (which are 21bp).

Uncertainty highlighted – but direction of travel is for tighter policy

We expect ECB to repeat the inflation and growth narrative from December, although with downplayed risks from Omicron effects and increased risks from the geopolitical tensions in Eastern Europe. That also means we expect that the risks for prolonged elevated inflation due to bottlenecks, high energy prices and wage growth outlook uncertainty will be flagged. We also expect the very negative real wage growth to be highlighted as a headwind to the economic outlook, and a concern to the eroding nature of the purchasing power. Importantly, we do not expect ECB to assess the current inflation as transitory, but as inflation shifting closer to the target while still settling below the 2% inflation target, in the baseline scenario. Despite all the above, we continue to believe that the direction of travel is for tighter policies from the ECB, but the pace is uncertain.

Financing conditions still easy, despite the rising real rates

Since the March meeting last year, the focus on real rates has been receiving a more prominent role. Since the start of the year, we have seen the 10y GDP weighted real yield rising above the levels seen through most of H2 last year. However, we do not expect this to be a major source of concern given the still the very low level in historical comparison.

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