Euro, Eurozone bond yields rise as Lagarde indicates potential hawkish shift at ECB

Reaction to the European Central Bank presser was substantial: EUR firmly bid, markets pricing in more rate hikes this year, front-end yields rising across the board…Stoxx 50, DAX etc weaker.

At last showing concern about inflation, the market views this as hawkish. EURUSD rallied to its highest since Jan 18^th, whilst EURGBP bounced after plunging to its weakest since 2019 on the BoE rate hike. The yield on the 10yr German bund jumped to a three-year high of 0.14%.

Key talking points from today’s ECB statement

Copy and paste job in the statement with no change to guidance or rates, as expected and confirming the Dec announcement.Still sees APP taper to €20bn from October, implying ongoing monetary stimulus for the rest of the year, which increasingly just doesn’t sit easily with what we are witness in the economy and in the market.

Key commentary from the ECB: Risks to inflation tilted to the upside, higher energy costs to act as drag on consumption, overall risks to the economic outlook at broadly stable. Market indicators indicate inflation to moderate in time even if elevated today and lasting longer than expected; bottles in supply chain are starting to ease, no signs of wage price spiral.

The surprise was reserved for the press conference with Christine Lagarde

Markets were pricing in 2 rate hikes in 2022 – Lagarde previously had said any hike this year was unlikely. She stumbled on at least 2 direct questions about this and did not repeat that it is ‘unlikely’ the ECB will raise rates this year. Specifically, she said: “I never make pledges without conditionalities, and it is very important to be very attentive to that at the moment. We will assess very carefully. We will be data dependent. We will do that work in March…We will be gradual in any determination we make.”

On the second iteration of this line of questioning she repeated no prediction was set in stone…that it was ‘conditional’ on the data…wait for March folks. Basically she is rowing back any forward guidance that was implied by saying any rate hike this year was unlikely….which the market read as saying you can now expect something this year.

On a very similar question on the market ‘getting ahead of itself’ with pricing 2 hikes this year, Lagarde reiterated the conditions for rate hikes…wait for March for PEPP QE runoff and fresh staff projections for the necessary cover for the volte face. That is also when any adjustment to the APP schedule can announced.

Lagarde reiterated that ECB won’t hike rates until net bond purchases have ended…but still planning to be net buyer of €20bn from Oct via APP… clearly doesn’t square with the market pricing and would require big shift in March statement. Lagarde reiterated that GC won’t be complacent but also will not be rushed.

Cannot rule out ECB, perhaps via the usual ‘sources’, pushing back on the apparent hawkishness, but it does seem the ECB has perhaps cracked and will raise rates sooner rather than later – look to March and fresh forecasts to provide the cover for a major change in the forward guidance.

Overall, it sounded like she was not pushing as hard against the market pricing as she has done so far and markets moved to price in 20bps ECB rate hike by September vs 10bps prior to those comments; 10bps by June, and 40bps by December.