Balazs Coranyi

FRANKFURT (Reuters – The European Central Bank will be affected by a flurry U.S. Federal Reserve rate rises over the course of the year. This is despite the fact that their policymakers are not concerned for now.

On Wednesday, the Fed signaled a rapid sequence of rate increases to lower inflation. This is a sharp departure from the ECB which continues to promise hefty stimulus in this year’s economy and has ruled out any increase until 2023.

The ECB stands by its stance on the basis of fundamentals. The European inflation rate is now lower than expected, wages are not as high, and the employment situation hasn’t recovered to pre-pandemic levels. This suggests that high inflation will pass.

Problem lies in Fed’s increased aggression. “Nimble” actions, as Chair Jerome Powell stated, suggest that the U.S. central banks will also complete their tightening cycles faster than ever before, which leaves the ECB with a smaller window of opportunity to move.

Piet Haines Christianen, Chief Strategy Officer at Danske Bank said that “if the Fed ends hiking in 2023,” then history will suggest they’ll think about cutting by 2024.

The ECB has a narrow window of opportunity to move because the Fed and ECB are on hold, or preparing for an easing cycle.

While the ECB is independent, it tends to follow closely the Fed. The handful of rate rises that the ECB made in sync with its U.S counterpart, such as those of 2008 and 2011, are often viewed now as policy failures.

Even in a hawkish setting, the ECB wouldn’t raise their first interest rate until the spring 2023. Analysts believe that this would allow for at least two additional increases to the Fed before it closes.

PAUSES AND Escape CLAUSES

While the ECB might move quicker, due to having missed its inflation target over a decade and having a record of misguided rate increases, the ECB is almost certain not to go faster. This is especially true with a dovish majority of its rate-setting Governing council.

Analysts only perceive timid moves that include pauses or escape clauses. This suggests that the ECB won’t only have a long lag but will be much more subtle in its actions.

This is a huge disconnect from the Fed, and markets are reluctant to trust the ECB’s rate outlook.

Despite Christine Lagarde’s explicit declaration that no move is expected this year, investors priced in 20 basis point increases prior to 2023.

The bank now faces a communication challenge at its February 3rd policy meeting.

Lagarde has resisted the possibility of an increase in its inflation rate, as it would be detrimental to her credibility. Pushing back might force her into a more restrictive position, which is risky given the unstable and uncertain inflation environment.

Frederik ducrozet, Pictet Wealth Management strategist said, “Under 2022, in spite all the pressure that they will face from high inflation and politics, they’ll still keep on stressing their sequencing of moves and by extension pushes back this year’s increase.”

The ECB has now stated that the rates would only rise after bond purchases end. They are expected to continue at least until the fourth quarter, and possibly for longer periods if necessary.

Ducrozet explained that “the problem is 2023” because markets will begin to price in the end for bond buys after then. This will even though large supply may be from Italy. It’s difficult to imagine ECB normalisation of bond market volatility.

This could make the ECB hesitant and fearful of rising debt costs, which could lead to a slowdown in growth.

If the ECB does not seize this opportunity to normalize policy, rates will stay deep in negative territory. This leaves it little room to ease during the next downturn. It also adds weight to criticisms that an ultra-easy policy is now the norm and not an exception.