The ECB's interest rate approach… While the Fed has been signaling to become aggressive towards inflation recently, it was a question of interest whether the ECB would adopt a similar stance in its multivariate perspective. Lagarde's emphasis on inflation risks, after the minutes announced last week with hawkish signals, shows that the ECB normally plans to increase interest rates. It is certain to go through a broad and deep evaluation phase.
German 2 – 10 year bond yield spread development… Source: Bloomberg
Asset purchases, bond spreads, instruments… Monthly net purchases under the APP will be €40 billion in April, €30 billion in May and €20 billion in June. At today's meeting, the Governing Council decided that data since its last meeting strengthened the expectation that net asset purchases under the APP should be completed in the third quarter. Calibration of net purchases for the third quarter will depend on the data and reflect the Governing Council's assessment of the evolving outlook.
According to the sources, the European Central Bank is working on a crisis tool that will come into play in case of a boom in bond yields in weaker eurozone economies. It's unclear what the instrument will look like, but such a vehicle could likely involve buying bonds in some way to control yields. Spreads were virtually unchanged, with yields rising steeply across the region and the highest since 2018. We are not yet sure about the general situation of the bond market in the Eurozone. The deterioration of the spreads indicates that the possibility of recession is priced in, and the harmonious increases in different maturities indicate the expectations of monetary policy tightening and higher interest rates, in addition to the post-Covid recovery.
The phenomenon of stagflation… The risks of slowdown in growth are much more intense than in the past, and the most important reason for this is the ongoing war. Inflation, on the other hand, will likely decrease in the conjugate period following the base effects, but may continue to remain high in the medium-term historically due to the nurturing facts of the prices of fundamental factors. All these cases point to stagflation risks. The issue that needs to be addressed here is that the high and unevenness of inflation may also cause a slowdown in growth. There is a decreasing activity effect from many channels, mainly a lack of supply, and this has a negative impact on final goods production. Both input prices are already high and there are secondary effects from the lack of final goods that increase base prices. Consumer behavior asymmetry also contributes to this.
Conclusion? Concerns about short-term inflation risks are more pronounced. Risks to the economic recovery are on the downside for the foreseeable future. Rate hike possibilities are still alive, but expectations for this will continue to show asymmetry for a while. Stagflation risks, strengthened by the Ukraine war, increase the uncertainty range. If there is no proactivity regarding inflation, there is a possibility that it will lead to a conjuncture in which stronger price increases will be necessary. If there will be a policy tightening that will not harm growth, real interest rates will not rise very much. However, growth risks stand at a point independent of monetary policy tightening due to the direct effects of the Russian crisis.
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