The rapid progress of the Ukraine war also makes the course of the following period uncertain, since the European Central Bank has to manage the monetary policy of an arena that is directly affected by the economy. The Bank, which will have to intensively discuss the asymmetric effects of new economic imbalances in the March meeting, may also make some dovish changes in the guidance. Officially, it seems that the predetermined route will be adhered to for now, but there is more uncertainty regarding the increase in monetary policy interest rates and it is possible that the Bank officials will take a more cautious stance compared to the previous month.
After signaling their intention to end net asset purchases and start policy rate hikes earlier in February meeting, we think that references in this direction are unlikely to strengthen in March. The closeness of Ukraine's influence and the stagnation of trade with Russia due to sanctions and commodity shortages also include economic recession risks that are directly relevant for the Euro Zone. Of course, in terms of revising macroeconomic indicators, especially GDP, it may be at an early stage since the numerical analyzes are not complete, but in terms of market uncertainty and supply-demand equilibrium points, downward revisions in the growth outlook and higher revisions in the inflation outlook may be in question in the projection updates. Changes to the ECB's forward-looking guidance at the March meeting should not be overlooked.
ECB OIS pricing… Source: Bloomberg
The first element is inflation… The ECB's forecasts include inflation rates of 3.2% for 2022 and 1.8% for 2023 and 2024. The risk of inflation remaining above the 2% equilibrium point increased due to oil and input prices. We will wait for the ECB to revise its forward rate assumptions upwards and possibly shift it above the 2% band. Energy prices will be an important determinant of how the ECB will ultimately respond. However, revisions may be limited as the Russian invasion has just begun and therefore the modeling data set for the March projection period is not fully formed. The next projection update meeting will be in June 2022.
The second element is growth. Economic shocks, sanctions and shortages of goods will also reduce demand and activity in the economy. We think that industrial activity, which will be directly affected by Europe's dependence on Russia, especially in energy, and Russia's counterparty risks, which the financial system carries, can focus on growth, demand and financial stability rather than high inflation, and therefore delay the rate hikes.
The third element, asset purchases… The Ukraine war element, which may be the subject of the ECB's postponement of a possible decision to reduce its bond purchases, should be closely monitored. expected under normal conditions; It was in the direction of the end of asset purchases towards the end of this year and an interest rate increase to be raised before the end of the year. In particular, we leave the possibility of the latter off the table at present, as the situation depends on the escalation or pacification of the war. We think that the Bank has not yet developed a flash response plan and is in the evaluation phase.
At the March 10 meeting, we will wait for more forward-looking signals in terms of monetary policy response and the formation of the Bank's stance change. Although Powell reiterated the Fed's commitment to upcoming rate hikes in his presentation to the US Congress, he also included the uncertainty stemming from the Ukraine war as an element of reservation. Markets see the Fed as justified in raising interest rates based on inflation and the assumption that the US economy will be affected very moderately by the Russian crisis. However, this is expected to occur at a lower tone than before, and the terminal rate is expected to be reached with a wider-term timing compared to two months ago. From ECB’s side; Lagarde, at the last meeting, helped mature the view that a rate hike could be made this year, but this rhetoric is difficult to sustain. Retrospective economic indicators will probably stay in the background as the factors that are the subject of the war period will be more up-to-date and we will look at the next direction.
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