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ECB today: Tightening cycle starts ahead of other major Central Banks

ECB today: Tightening cycle starts ahead of other major Central Banks

7.4.2011 9:55

Today, all eyes will be on the key ECB meeting. ECB starts its tightening cycle ahead of other major Central Banks:
…ECB to raise rates by 25 bps in line with expectations, but…. 
…Mr. Trichet may do its upmost best to keep uncertainty about the next move…. 
….as the ECB acts before the Fed and at a time peripheral economies are still in or near recession… 
…to avoid confusion, ECB should stay idle on other key policy issues 

If he doesn’t succeed in his mission “almost” impossible, market rates and the euro may spike At its March meeting, Mr. Trichet announced the clear intention of the ECB to raise its key policy interest rate at the next meeting on April 7. Given that the world remains a very uncertain place he gave the ECB some wriggle room by adding that the ECB never pre-commits and a “rate increase next month is “possible”, but “not certain”.

Most observers were surprised by the timing of the announcement in March as an ECB rate increase wasn’t expected until much later in the year. In the interim, doubts about Trichet’s promise grew during the month, as a major earthquake occurred in Japan and geopolitical problems in oil-rich MENA flared up. However, after the mid-month non-monetary policy meeting, several ECB governors made it very clear that any changes resulting from the new uncertainties were not important enough to change the ECB’s mind regarding interest rates. Therefore a 25 bps rate rise seems to be a done deal. However, this doesn’t mean the ECB meeting won’t be highly interesting. The assembled journalists will question Mr. Trichet thoroughly on the outlook for monetary policy in the wake of today’s rate hike. Other contentious issues that may prompt questions include nonconventional policy, notably the liquidity provision for banks and the Securities Market Programme SMP and ECB decisions on collateral following the ECB stress tests. The recent Irish stress tests and uncertainty about special measures to provide medium term funding could also be raised by the media.

Markets have widely anticipated the 25 bps rate hike, but will react on the outlook Mr. Trichet will give. Our view of a 2% refi-rate by the end of 2011 is more aggressive than current market pricing, but we think Mr. Trichet will try to copy the “2005” trick and disappoint those who want to hear the ECB is overtly increasing its hawkishness. Once more looking to 2005, the 2-year German yield rose 15 bps on the pre-announcement on November 18, but fell on the day of the decision and the day after. Will there be a similar reaction? We would draw the attention on the crucial levels many markets have arrived at the eve of the crucial ECB meeting. In the bond markets, the Bund test the 120.92 (neckline double bottom), which if sustain-able broken might trigger another down-leg with first support at 120/121.85 (similarly the 10-year yield arrived at key levels). The EUR/USD yesterday moved above 1.4282 resistance. If confirmed it theoretically open the road for a further substantial rise of the euro. This underlined once more the importance of today’s ECB decision and guidance.

Please download full report from Currencies & Rates / Analyses section.


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