Lagarde and the Governing Council keep up their guard
- At its monetary policy meeting on 14 December 2023, the European Central Bank (ECB) kept all key interest rates on hold, for a second consecutive meeting.
- The ECB announced that reinvestments of the Pandemic Emergency Purchase Programme (PEPP) will decrease by 50% from July 2024.
- President Lagarde stated that the Governing Council (GC), will not let its guard down in the fight against inflation.
Key policy rates remain unchanged
At the conclusion of its final monetary policy meeting of 2023, the ECB kept all three key interest rates unchanged, maintaining the refinancing rate at 4.50%, the marginal lending facility at 4.75% and the deposit facility rate at 4.00%. This meeting was the second consecutive pause, as the ECB moves through a series of meetings where rates will remain unchanged.
EXHIBIT 1: THE ECB DEPOSIT RATE REMAINS AT AN ALL-TIME HIGH OF 4.00%
Source: J.P. Morgan Asset Management and Bloomberg; data as of 14 December 2023.
Once again, the decision to pause was widely expected, with eurozone inflation having “dropped markedly” over recent months as the effects of monetary tightening continue to forcefully feed through to the economy, dampening demand and reducing price pressures. Updated inflation forecasts predict a steeper reduction of inflation back to the ECB’s 2% target, compared to the ECB’s previous estimations from September. The latest average annual inflation estimates are as follows (with September’s forecasts in brackets): 5.4% in 2023 (5.6%); 2.7% in 2024 (3.2%); 2.1% in 2025 (unchanged); and 1.9% in 2026.
Eurozone growth is set to improve over the current forecast horizon, as rising wages, together with falling inflation, lead to an increase in household real wages. Average growth of 0.6% in 2023 will increase to 0.8% in 2024 and to 1.5% in both 2025 and 2026.
During the press conference, President Lagarde was asked whether the GC had discussed future rate cuts. Her response was that the GC believes that there is “still some work to be done” to ensure inflation is brought back to the target level, firmly stating that the GC “did not discuss rate cuts at all” and that it would not be moving from rate hikes towards immediate rate cuts.
On the contrary, the GC is now in the transition period between cycles, believing that the eurozone will avoid a recession, thereby alleviating the need to reduce rates in the near term. Any rate cuts priced into the market during the first half of 2024 therefore appear to be premature.
Balance sheet normalisation
After much market speculation, the ECB has amended its forward guidance on PEPP reinvestments. Previously, all guidance suggested reinvestments would continue until the end of 2024. Although December 2024 will still see the end of all reinvestments, the ECB will now taper down these purchases by EUR 7.5 billion per month, commencing in July 2024. President Lagarde commented that she saw this amendment as balance sheet reduction, as opposed to monetary loosening, reaffirming that the key policy rates remain the primary monetary policy tool.
EXHIBIT 2: PEPP HOLDINGS WILL BE REINVESTED UNTIL JULY 2024, FOLLOWED BY A CONTROLLED TAPER OF MATURITIES.
Source: J.P. Morgan Asset Management and ECB, as of 30 November 2023.
Implications for euro cash investors
With no increase to the ECB’s deposit rate, euro cash investors won’t witness an immediate increase in yields from a liquidity fund’s overnight investments. However, the ECB’s reluctance to discuss rate cuts at this moment in time can give greater comfort to short-dated cash investors that yields will likely remain at their current levels as we progress through the first half of 2024.
Maturing securities in J.P. Morgan Asset Management’s euro liquidity strategies will continue to benefit from higher reinvestment rates, derived from previous increases in the ECB deposit rate. By moderately increasing the funds’ weighted average maturity during this transition period, from a hiking cycle towards potential rate reductions, our portfolios are well placed to lock in investments while yields remain higher.
With the peak in rates likely now upon us, we believe investors can be more comfortable adding some duration risk while maintaining an active approach to cash management, prioritising diversification and liquidity.