Overview
What happened?
At its March meeting, the ECB reduced its planned Asset Purchase Programme (APP) buys to an average of EUR 30 billion a month in Q2 and signalled the end of the quantitative easing (QE) programme in Q3. The forward guidance saw two key changes. The reference linking the end of the APP and the ECB’s first rate hike was changed from "shortly" to "some time after", adding flexibility to the timeline. The bank also dropped the hint that interest rates might be cut further, given the sharp rise in economic uncertainty.
Our interpretation
The accelerated tapering timeline came as a surprise to us and markets given the sharply increased uncertainty since the last meeting. In light of the war in Ukraine and its devastating consequences, we had expected a more cautious tone from the ECB. The revised baseline staff projections saw only a limited downward 2022 growth revision but substantial upward revisions to both headline and core inflation, which evidently led the Governing Council to stick to this year’s hawkish pivot. As the war continues, the bank’s assessment of the risks to inflation and growth, and its commitment to being dependent on the data, will be tested in the coming days and weeks.
Outlook
The world has changed dramatically since the ECB's last meeting. We have war in Europe, sanctions, and a humanitarian disaster. The huge energy shock, combined with tightening in financial conditions, looks very likely to push Europe into a recession that will last through the second half of 2022, and possibly beyond if the conflict escalates further. At the same time, inflation had already been high going into this shock and is now set for further acceleration given the massive supply chain disruptions and commodity price rises. In this context, the ECB is facing a huge dilemma over the next few months.
We believe that as the impact on growth becomes more evident in the data over the next few weeks, the bank’s focus will likely shift away from high inflation towards an attempt to limit the economic and market distress as the consequences of the invasion ripple through the system. Contrary to market pricing, which points to a rate lift-off as soon as July 2022, we do not expect the ECB to hike interest rates this year. Moreover, we believe there is a substantial risk that the bank might have to extend the APP, rather than wind it down, especially in the event of significant disruptions to gas supply from Russia to Europe.
Asset allocation views
As things stand, the balance of probability points to further uncertainty and downside risks to come. As a result, earlier this month we changed our core multi asset positioning to be underweight equities after being neutral previously. We remain underweight credit and neutral on government bonds.
The invasion will cause a severe stagflationary shock, with the potential for a severe 1970s style energy crisis as Russian exports get cut off from world markets. We expect significant two-way volatility in the coming weeks from each incoming piece of news and reduced liquidity.
