After the July meeting of the Governing Council, the European Central Bank will today announce the launch of its new crisis management tool. We predict that it will lack specifics and disappoint investors. This, along with an even more hawkish stance on monetary tightening, could put more upward pressure on periphery bond rates.
We anticipate that the members of the Governing Council won’t be able to agree on the crucial specifics of what constraints will be placed on future bond purchases and what will cause the instrument to be used. The ECB will raise interest rates this month by at least 25 basis points; however, the possibility of a move of 50 basis points has increased dramatically. The shift amount would likely depend on how far the anti-fragmentation tool is developed; a significant increase would be risky if the Governing Council could not resolve any issues in peripheral bond markets.
Although we believe a more significant increase is all but guaranteed, the ECB appears unlikely to provide any further information on whether the interest rate hike in September would be 25 or 50 basis points. The evaluation of threats to inflation and growth forecasts might be utilised to provide policy indications. The Governing Council’s emphasis on current inflation, combined with another price overshoot in June, suggests that the risks are slanted toward more hawkish rhetoric.
A meeting with more critical discussions to be held might be too contentious. Still, the Governing Council may provide additional remarks on its estimate of the neutral policy rate for the euro area to limit expectations for medium-term rates.
The Governing Council must handle major and contentious issues about the new crisis management tool. According to an ECB leak document seen by Bloomberg News, the Governing Council has so far just agreed on a name — the Transmission Protection Mechanism. The Governing Council may be under pressure to take action due to Mario Draghi’s recent political difficulties in Italy, but reaching a consensus won’t be simple.
Questions To Ask
What will cause the new tool to be used? How will the ECB determine if spread increases are unjustified and prevent monetary policy from being transmitted? What restrictions will apply when utilising the tool? Which kind of surveillance will be placed on the receiving nation, and will they be regarded more acceptable than those permitted under the programme for outright monetary transactions? What kind of weaponry will be on hand?
The Risk
The ECB has made it evident that a hike of at least 25 bps in July is a done deal. The Governing Council may unexpectedly raise interest rates by 50 basis points, as some hawks have been calling for.
Since the second publication of June’s inflation statistics indicated that underlying price hikes are still on the rise, the threat of a higher rate is increased. The price of products and services that exhibit minimal responsiveness to the business cycle and package vacations are excluded from our preferred measure of supercore, which rose to a new record high of 4.6 per cent in June from 4.3 per cent in May. Currently, financial markets are estimating that the more significant shift will occur with a likelihood of roughly 50%.
Going Forward
The climb scale slated for September will be another discussion topic during the July meeting. The new medium-term inflation outlook will determine how this rate rise is calibrated. The ECB’s Monetary Policy Decisions statement for June stated that a greater increase might be warranted at the September meeting if the medium-term inflation outlook persisted or worsened. Although the ECB won’t likely provide additional explicit advice on the rate path, the risk assessment will be extensively scrutinised for any cues on the direction of upcoming forecast revisions and the outlook for policy.
We anticipate the ECB to increase all three key policy rates by 25 basis points in July and 50 basis points in September. Then, according to our prediction, the Governing Council will increase those rates by 25 basis points in October, December, February, and March. Last but not least, we anticipate a 25-bp hike in the deposit rate alone in June.