ECB Research 10bp, 20bp or …? ECB in uncharted waters
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We continue to expect the ECB to raise the deposit rate by 10bp in Q2 19, also after weighing the arguments for the size of the hike in this note.
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The degree of subjectivity regarding the first hike is high. We doubt even the ECB's GC members have formed a view, yet.
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For market pricing, we argue that it is neither the size nor the timing that is crucial to markets, but how the first hike is communicated and its subsequent rate path.
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We believe that the risk/reward for the ECB coming earlier with the hike rather than later is not balanced. We recommend receiving 2Y2Y EUR swap outright.
Recently, market speculation about the first rate hike from the ECB has resurfaced, not only on the timing but also on the size of the first hike. Most recently, Reuters reported a Q&A with the ECB's Chief Economist Peter Praet on Friday touching on this topic as well as yesterday when ‘ECB sources' suggested that the focus in the Governing Council could be turning towards the interest-rate path.
That the size of the first hike is uncertain is new to modern monetary policy and the fact that the size is unknown complicates the discussion on the market's usual questions; ‘what is priced in?' and ‘is the market pricing fair'?
In the following note, we reflect on elements that we expect to play an integral part in the Governing Council's (GC) decision to hike rates. As the size is uncertain the degree of subjectivity regarding the first hike is high. Ultimately, we argue that on balance we expect the ECB to hike by 10bp in Q2 19. The size and timing needs to be seen in the light of our view of the ECB communicating a slow and gradual normalisation as well as testing waters towards higher rates. Controversially, we conclude that it is neither the size nor the timing of the first hike that is crucial to market pricing; it is the communication that accompanies the hike that will drive the markets.
Taking profit. we sent out a trade recommendation to receive Dec-18 to Mar-19 EONIA swap. Our main argument for this trade was the stretched pricing from a sequencing perspective at a time when markets already had a first 10bp hike in Q1 19. The trade has reach the target and is therefore closed with a profit of 5.2bp.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
