ECB stays the course towards inflation reduction
- The European Central Bank (ECB) raised its key interest rates by 50 basis points (bps), in line with expectations to a 15-year high of 3.00%.
- In the accompanying statement and subsequent press conference, the ECB maintained its hawkish tone, signalled an intention to increase rates by a further 50 bps in March.
- Yields on Euro money market strategies should continue to trend upward as interest rates on deposit, repo and short-term securities increase.
A fifth consecutive hike – with more to come:
At its first monetary policy meeting of 2023, the ECB increased its three key interest rates by 50 bps, bringing the refinancing rate to 3.00%, the marginal lending facility to 3.25% and the deposit facility rate to 2.50% (Exhibit 1). This represents the fifth consecutive rate hike by the central bank.
The accompanying statement remained hawkish, stating that “the Governing Council will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive to ensure a timely return of inflation to its 2% medium-term target”.
While the ECB continued to stress that future policy decisions should be data dependent, President Lagarde justified the dichotomy by highlighting that inflation remained sufficiently high to justify a further hike in March. However, her comment that the ECB would “evaluate the subsequent path of its monetary policy” after the March policy meeting was also interpreted by the market as a more dovish signal.
Exhibit 1: The ECB deposit rate has increased to the highest level since 2008
Exhibit 2: Headline inflation continues to fall, but core inflation remains sticky
Inflation and growth outlook now more balanced:
Notably, the ECB assessed that inflation risks have become more balanced: Wage increases (driven by inflation and low unemployment), together with increased demand as the Chinese economy reopens represent upside risks. Conversely, accelerated falls in energy prices have reduced headline inflation (Exhibit 2) faster than expected. As a result, President Lagarde called on European governments to ensure that fiscal energy support is temporary and targeted, to limit the inflationary impact of these measures.
Despite multiple negative factors including the pandemic, Ukraine war, higher interest rates and slower lending, the ECB believes that the eurozone economy has proven to be resilient, eking out 0.1%q/q growth in the fourth quarter of 2022, and likely a further recover in 2023.
Implications for euro cash investors
Short-term interest rates have moved higher (Exhibit 3) and the curve has steepened in anticipation of further ECB rate hikes (Exhibit 4). J.P. Morgan’s Euro Liquidity strategies were well positioned for the additional ECB tightening, with low weighted average maturities (WAM) and investments concentrated in shorter tenor securities. Euro cash investors will immediately benefit from a significant increase in money market fund yields as deposit rates and investment levels reset higher, although it may take a few weeks for reinvestment to catch up fully.
Exhibit 3: Money market rates have moved higher
Exhibit 4: Yield curve remains relatively steep
As President Lagarde highlighted, the risks to both growth and inflation remain finely balanced and there is still much uncertainty surrounding the economic outlook. Nevertheless, given its forceful rhetoric, we believe the ECB will continue to tighten monetary well into the second quarter of 2023. While ultimately the central bank will pause, for now we recommend a cautious, diversified and liquid approach to investments - ensuring good diversification, while allow investors to quickly reap the benefits of additional future rate hikes.