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Market Update

The ECB holds firm while the BoE wavers

December 15, 2022


On 15 December, the European Central Bank (ECB) voted for a further 0.5% interest rate increase as the central bank continues its policy of monetary tightening in the face of high inflation. The bank slightly slowed the pace of increases (from 0.75% previously) as signs of a softening inflation picture have started to emerge. The narrative in the press conference, however, was more hawkish than expected.

By contrast, the Bank of England (BoE) was split in its approach by voting 6-2-1 for a further 0.5% hike. Signs of division emerged within the Monetary Policy Committee (MPC) with two members voting for maintaining the current levels, and one member voting for a 0.75% hike. The U.K.’s weak economic performance and the spectre of stagflation overshadowed the need for continued aggressive hiking.

Key takeaways

  • The BoE raised the base rate by 0.5% to 3.5%
  • The ECB raised the Deposit Facility Rate by 0.5% to 2.00%
  • As of 12:30 GMT, the 10-year GBP swap traded at 3.34%, 5-year at 3.69%, 3-year at 3.97%
  • As of 13:45 GMT, the 10-year EUR swap traded at 2.63% 5-year at 2.65%, 3-year at 2.78%
  • The vote was split 6-2-1 reflecting division within the MPC
  • The tone from the ECB suggested rates would continue to rise “significantly”

The ECB is sticking true to the course laid out by Christine Lagarde in recent press briefings where she stressed that rates would need to continue to rise, even in the face of a sputtering economy, to bring inflation under control. Lagarde addressed EU legislators and stated that uncertainty, a tighter monetary environment, and weakening global demand are weighing on growth, which is “expected to continue weakening for the remainder of this year and the beginning of next.”

The rate hikes are taking their toll across the EU with the news this week that even national banks are feeling the strain. The National Bank of Belgium (NBB), Belgium’s central bank, had trading in its shares suspended on Monday as prices plunged to their lowest levels since 1996. The impetus for this sell off came on their announcement that they expect €9 billion in losses in 2023–2026, as a result of ECB interest rate hikes, completely wiping out all of the NBB’s provisions and equity,sending ripples of shock through the broader capital markets.

This underscores the delicate balancing act being undertaken by Lagarde and the ECB as risks to the financial stability of the Eurozone increase. The Russia-Ukraine war, soaring prices, and low growth lead to concerns that the stresses on the financial markets could create a single point of failure, which then cascades into a broader contagion, potentially putting key economic infrastructure at risk. The current macro environment represents some of the most rigorous stress testing of the post 2008 regulation and its impact upon financial stability across the bloc.

The language used in the press release and the following conference struck a more hawkish tone than markets anticipated, with the ECB using strong language in the face of an upward revision to the inflation outlook. Lagarde said, “rates would still need to rise significantly at steady rates to reach levels that are sufficiently restrictive to return inflation to the 2% target.”

EUR swap rates rose sharply at the short end of the curve before settling back following the announcement. The 3-year EUR swap rate was up 6 bps to 2.78%, the 5-year EUR swap rate was up 5 bps 2.65%, and the 10-year EUR swap rate was up 3 bps to 2.63%. The expectation is for rates to increase by a further 50 bps at the next meeting in February, and the peak of projected rates increased 6 bps from 2.84% to 2.90% in the second half of 2023.

The BoE voted 6-2-1 to raise the U.K. base rate by 0.50% to 3.50%, with dissenters split, voting for hikes of 0.75% and keeping rates as they were. The pattern of votes represents some of the deepest divisions in the MPC in recent times with an ideological battle between the hawks and the doves on the best way to handle the current challenging economic circumstances.

Central Bank staff are broadly anticipating a recession in early 2023 with a projected 0.1% reduction in GDP in Q1. The risk of stagflation, the process by which the economy suffers but inflation remains high, seems to be at the forefront of the debate with concerns about longstanding damage to the U.K.’s economy and workforce highlighted in the letter from Andrew Bailey to the chancellor where he highlights that, “there are considerable uncertainties around the outlook. The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary.”

The Bank outlook on inflation is marked in the commentary that YoY CPI has peaked following the fall from 11.1% in October to 10.7% in November. However, this view is moderated slightly with the caveats that the U.K. labour market remains strong, despite a small uptick in unemployment figures, and an upside risk on wages. With private sector pay rising above expectations, and the U.K. battling some of the most aggressive strike action in decades from a wide range of public sector workers over the cost of living, the Bank’s Agents expect further upward pressure on pay growth next year.

Markets are pricing in 1.6 hikes at the next MPC meeting in February for a total projected increase of 0.41%. This is 7 bps lower than pre-meeting projections of 0.48% and the peak of projected rises came down by 20 bps when compared to yesterday’s numbers.

GBP swap rates fell at the short end of the curve following the announcement. The 3-year GBP swap rate was down 7 bps to 3.97%, the 5-year GBP swap rate was down 6 bps to 3.69%, and the response in the 10-year GBP swap rate was more muted at 3.34% from 3.38%.

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