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The ECB’s strategy

02 June 2022

On June 9th, the ECB meets and releases its quarterly forecasts for growth and inflation cementing at least two rate hikes this year. It should justify the end of the Quantitative Easing program known as APP in June or July. Most of the market participants expects the ECB to point the way to a series of quarterly rate hikes. The swap market prices in a slow pace of rate hikes followed by an acceleration but please note that the swap curve is twisted as a lot of cash is parked in short term rates and lower (we can even say depressed) due to the ECB Quantitative Easing program suggesting some upside move as the policy starts to become more restrictive.

“Inflation is not only too high, but also too broad” said ECB Villeroy de Galhau (2/6/2022). This is the essence of the problem for the ECB. Inflation is yet to ebb as too much demand met a very stretched supply chain, with inflation widening from goods to services (3.5% service inflation). This is happening as real interest rates remain deeply negative (see graph below). Furthermore, inflation erodes good will politically and forces households to find better wages creating eventually a dangerous wage inflation spiral. That is leading some to expect the ECB to push for 50 basis point rate hikes much as the Fed was forced to.

As the ECB tightens at a steady pace and may eventually be forced to tighten faster, we should see the EURUSD rise as the impact of negative interest rates fades on what is an unstable level. A higher EUR would help the Eurozone cope with imported inflation.

What does it mean?

While the path for Eurozone fixed income is yet to settle and is still shrouded with uncertainty such as the risk of a short recession, peripheral fixed income is starting to become appealing.

Source: Nordea Investment Funds S.A. and Bloomberg

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