ECB sticks with 50bps hike, despite market turmoil.
- The European Central Bank (ECB) acted on February’s forward guidance by increasing key interest rates by 50 basis points (bps), despite current market volatility.
- In the accompanying statement and subsequent press conference, the ECB’s president, Christine Lagarde, maintained that inflation was forecast to be too high, for too long.
- In a move away from forward guidance, the ECB stated that future monetary policy decisions would be data dependent.
- We believe that yields on euro money market strategies should continue to trend upwards as interest rates on deposit, repo and short-term securities increase.
A turbulent week fails to divert the ECB from its path
At the conclusion of its latest monetary policy meeting, the ECB increased its three key interest rates by 50bps, bringing the refinancing rate to 3.50%, the marginal lending facility to 3.75% and the deposit facility rate to 3.00% (Exhibit 1). These increases were flagged during the press conference that followed 1-2 February’s meeting.
However, in a turbulent week that saw the closure of two US banks as a result of liquidity issues and a crisis of confidence in a large Swiss bank, many market participants questioned whether the ECB would choose a more cautious approach.
The accompanying statement highlights that the ECB is monitoring the current tensions, stressing that it has a full toolkit available to preserve both price stability and liquidity.
Macro forecasts are cut but uncertainty is high
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.
Baseline inflation and growth forecasts, compiled at the beginning of March, were revised downwards. Headline inflation was cut to 5.3% in 2023, 2.9% in 2024 and 2.1% in 2025, while growth was cut to 1.6% in both 2024 and 2025 (although revised up to 1% for 2023). Despite the moderation in headline inflation forecasts, core inflation was revised up to 4.6% for 2023, from 4.2% (Exhibit 2), and this upward revision appears to have been a key factor behind the decision to raise interest rates. However, recent events have added to the uncertainty around these forecasts and the ECB will pay close attention to incoming data, while remaining determined to bring inflation back to its target level in the medium term.
The European banking sector is resilient
The ECB expressed confidence in the strength of European banks, stating that “the euro area bank system is resilient, with strong capital and liquidity positions”. The ECB remains ready to use multiple monetary policy tools to maintain a stable and functional banking sector.
Implications for euro cash investors
Short-term interest rates have moved higher (Exhibit 3) although the curve has flattened, as the market anticipates that the ECB is getting close to the end of this tightening cycle (Exhibit 4). We believe that J.P. Morgan Asset Management’s euro liquidity strategies can maintain a high level of liquidity and stability, and are well positioned for any further financial market volatility, with low weighted average maturities (WAM) and investments concentrated in high quality, shorter tenor securities. Euro cash investors could quickly benefit from a significant increase in money market fund yields as deposit rates and investment levels reset higher, although it will take a few weeks for the reinvestment of future maturities to catch up fully.
As affirmed by the ECB’s president, Christine Lagarde, uncertainty remains high, especially following recent events. Overall, however, the strength of the European banking sector, in addition to the multitude of options available to the ECB, has given the central bank the confidence to tighten policy further in order to help bring inflation back to its medium-term target. The removal of a commitment to further hikes suggests that a peak in rates could be getting closer, but if recent volatility subsides, then there may be “more ground to cover”. With markets likely to remain volatile in the near term. J.P. Morgan Asset Management’s liquidity fund range aim at maintaining a diversified and liquid approach to investments to ensure high levels of liquidity, while a controlled active management investment approach should allow investors to quickly reap the benefits of additional rate hikes.