The impression that yesterday’s European Central Bank meeting left – given the magnitude of events – was a relatively balanced one amid this environment of high uncertainty. Unsurprisingly, there was an acknowledgement of the increased upside inflation risks, but also of the downside risks to growth. Importantly, without really passing judgement as to what will hold more weight at this juncture.
There is a clear readiness to act, however, which itself is a hawkish shift in the ECB’s stance. And President Christine Lagarde highlighted that the ECB will monitor everything from supply bottlenecks and firms’ price-setting intentions to wage developments to determine the pass-through of the shock. Lagarde stood by a data-dependent and meeting-by-meeting approach to assess the ECB’s appropriate policy stance.
While the ECB did not seem to signal imminent action at its meeting, subsequent press reports suggested that some officials were ready to raise rates as soon as April. The market is now fully discounting two hikes and the possibility of more this year. The upcoming April meeting has an implied probability of a 25bp hike of over 60%. But at the same time, markets do not set prices in a vacuum, and we saw, for instance, that just prior to the ECB meeting, markets digested a surprisingly hawkish Bank of England that also dragged up EUR rates – highlighting again that there is some element of positioning in play as well, and that market pricing should not be taken entirely at face value.
For now, oil prices and geopolitical developments will remain in the driving seat. That is until we reach a tipping point where adverse risk sentiment takes over. What we did observe was that the long end has had a greater struggle to keep pace with the rise in short-end rates. While the 2y swap rate has settled 15bp higher on the day, the 10y swap rate only got past the 3% mark briefly. 30y rates are outright lower on rising front-end rates for the past two sessions, accelerating the common flattening dynamic seen when front-end rates rise.