The statement and Lagarde’s presser gave us guidance for the May meeting is hazy and some may have expected comments regarding the bank’s intention to accelerate QT in the third quarter.
Last meeting Lagarde establishing herself as the biggest hawk among top central bank officials. Already, a few weeks later, she has had to soften her stance—while remaining the top G10 hawk—given the more favorable energy prices backdrop that has quickly rendered the Q4 projections as NOT correct.
Market pricing for the bank’s terminal rate is lower by about 15bps and contracts are now seeing a peak deposit rate of 3.50% in June equivalent to hikes of 50, 25, and 25 in March, May, and June, respectively.
With no comments around an accelerated QT pace in Q3 and the softer policy outlook from the ECB today, Italian yields were sharply lower across the curve.
Yields on 2-yr German bonds are down 15-20bps compared to 25-30bps in Italy. In the 10-yr space, BTP yields are down 40bps compared to 20bps in Bunds for an 20bps decline in the spread between these two to about 180bps, correcting an important share of the widening seen since mid-month.
Traders may have anticipated that the ECB would speak to a faster QT in the second half of the year, maybe it was too much to hope for a faster QT when QT hasn’t even begun (March 2023 at a pace of €15/month until June)
With the Lagarde stuttering still anticipate a 50bps hike in March with risks tilted towards a quarter-point increase in May to be followed by a final equivalent hike in June. The ECB remain data-dependent and cannot yet confidently bank on inflation pressures not remaining elevated in coming months—but a continued negative trend in headline inflation even if accompanied by stubbornly high (but cresting) core inflation has a calming effect on wages pressures and the risk perception of policymakers.
With several months’ worth of data until mid-year that could show continued declines in inflation, as expected, the bank may find little motivation in hiking again three meetings from today and instead choose to hold its fire in June ahead of a long pause.