• “High inflation is a major challenge for all of us. The Governing Council will make sure that inflation returns to its 2% target over the medium term.” The short opening paragraph of today’s ECB monetary policy decisions says it all. The central bank finally acknowledges the global inflation problem and embarks on a journey to normalize monetary policy from next month onwards. Net asset purchases under APP will end as of July 1st with the Governing Council intending to raise key interest rates by 25 bps at its July meeting. Looking further ahead, the ECB also expects to increase rates in September, but it doesn’t commit to an exact number yet. The calibration will depend on the updated medium-term inflation outlook. New estimates today pencil in 6.8% inflation this year (from 5.1% in March), 3.5% in 2023 (from 2.1%) and 2.1% in 2024 (from 1.9%). If this outlook persists or deteriorates, a larger increment (50 bps) will be appropriate. Beyond September, the central bank commits to a gradual, but sustained path of further interest rate hikes with the pace depending on incoming data and the medium term inflation assessment at that time. Ceteris paribus, we expect back-to-back 50 bps rate hikes in September and October with December forecasts the earliest opportunity to revert to 25 bps moves. Our preferred scenario suggests a third consecutive 50 bps move. As some kind of back-up plan, the ECB said that it can adjust reinvestments (from its PEPP-portfolio (which will run at least until the end of 2024) if necessary to counter potential market fragmentation stemming from the policy normalization. This could include purchasing Greek bonds over and above rollovers of redemptions. The consequences of the Russian war against Ukraine weigh on growth, but these worries are overshadowed by the need to tackle inflation and revert inflation expectations towards the 2% target. The economy is nevertheless expected to continue to grow on account of the ongoing reopening of the economy, a strong labour market, fiscal support and savings built up during the pandemic. The ECB downgraded growth forecasts significantly for this year and next, respectively from 3.7% to 2.8% and from 2.8% to 2.1%, while beefing up the 2024 forecast from 1.6% to 2.1%.
• Interest rate markets reacted to the strong ECB signal and hints on >25 bps rate hikes in September and perhaps even beyond. German Bunds significantly underperform US Treasuries. The German yield curve bear flattens with yields rising by 13-14 bps (2 to 5-yr) to 4.6 bps (30-yr). European money market now discount almost 150 bps of cumulative rate hikes by the end of 2023. US yields add 2.7 bps (30-yr) to 4.6 bps (5-yr). The single currency trades volatile, but stronger. Gains could have been larger though. EUR/USD is changing hands around 1.0750, falling short of really testing key support at 1.0806. Taking out that mark would turn the technical picture in the pair neutral. The fierce sell-off on bond markets spills into equity weakness with European bourses losing over 1%.
• Dutch gas futures spiked more than 16% in early trading before paring gains to about 10% today after a fire erupted at a large LNG export terminal in the US. With the US exporting almost 75% of all LNG to Europe in the first four months of the year, the news sparked renewed supply worries. Energy companies may have to turn to inventories again just as European storage levels have just improved closer to historic averages. The Texan gas facility involved in the fire makes up about 20% of all US exports of the fuel and will remain closed for at least three weeks. It comes at a time when supplies from other top gas providers, including Norway, are capped too for annual maintenance this week. Gas prices currently hover around €86/MWh.