ECB Review – Confirmed: Today’s meeting was a prelude to December

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  • Today’s ECB meeting ended without new decisions or a signal of the decisions to be taken at the December meeting, as widely expected (see our preview here). Lagarde personally expected PEPP to end on March 22. TLTRO would be part of the December discussion.
  • The ECB concluded that the growth risks are broadly balanced, while acknowledging that the euro area is witnessing a slower momentum.
  • The ECB’s provisional inflation story, citing rising energy prices, supply demand mismatches and German VAT base effects as the main drivers for current high inflation rates.
  • As for market prices, there has been some murky backlash that leaves ECB data dependent. To date, the ECB has not cared about the recent increase in the impact of short-term tariffs on financial conditions.

Inflation, inflation, inflation – but not like other central banks!

At today’s ECB meeting, ECB discussed three issues according to Lagarde: Inflation, inflation and inflation. She boiled down the conclusion to three factors driving inflation (see below) that led the ECB to conclude that the recent inflationary pressures are transient.

We had two main questions we were looking to answer today

1) Not like other central banks: Asked about the question of ECB compared to other central banks which is getting sharper, she said the comparison is “disgusting”.

2) Market prices are ahead of their own: Lagarde has been asked several times about this issue. The first time it was clear that ECB disagreed with market price, however the subsequent responses were less convincing, which also leads to a strong intraday reaction in markets where for example 1y1y EONIA exchange traded within 12bp top to bottom range through the press conference. . She said this about her clearest answer; “Our analysis certainly does not support that the conditions of our previous leadership are satisfied at the time of take-off as expected by markets nor shortly thereafter,”

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Ultimately, we believe that the ECB does not expect to raise tariffs in the foreseeable future due to the ECB’s transitional inflation story. Whether this newly found data dependency will continue remains unknown. Anyway, if inflation proves to be longer lasting, the comments today make us less certain that the ECB would not change policy rates eventually.

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ECB says inflation growth is transitory, but markets doubt it

During the press conference, Lagarde stressed that the eurozone economy continues to recover strongly, although the momentum has moderated. While consumer spending remains strong, supply shortages are slowing production, obscuring the outlook for the coming quarters. That said, risks to the economic outlook are still viewed as broadly balanced and Lagarde has also lowered the risk of stagflation, arguing that at first there is no “stagnation” (just a slightly slower growth momentum).

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Lagarde also clearly remained true to the ECB’s provisional inflation story, citing 1) rising energy prices, 2) supply-demand mismatches and 3) base effects (like German AVI) as the main drivers for current high inflation rates. While inflation is expected to remain high in the near future (lasting a little longer than previously expected), the ECB still expects inflationary pressures to decline again over the next year. One important reason for this remains that the ECB does not yet appear to be concerned about a wage price spiral, stating that the gradual return to full capacity will sustain wage growth only “over time”. Upcoming wage rounds in Germany during 2022 will be key to observing in this regard in our opinion (see Euro Area Research – German Wages: What to Look for in 2022, October 25). However, with Spanish and German CPI inflation rising to the highest level since the 1990s in October and price expectations still adjusting across sectors, markets are increasingly discounting the ECB’s provisional inflation story.

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EUR / USD increase to prove provisional

Despite Lagarde’s very appropriate signals and overall appearance, EUR / USD followed the rate market higher. In our view, this is likely to be a temporary correlation and is likely to be replaced by more downside risk soon, as the European economy is undermining amid inflationary surprises. We generally do not see much link between spot EUR / USD and rising expectations to Euro-regional interest rates. Conversely, the Fed is likely to lean more toward its hawkish views and likely, too, the economy is better equipped to deal with a slight slowdown in growth and higher yields. On the net, we continue to forecast 1.10 in 12M EUR / USD.

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