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Fidelity’s Stupnytska on today’s ECB meeting: “Too much too soon could be a riskier strategy”

Anna Stupnytska, global macro economist at Fidelity International, comments on today’s ECB meeting:

“At its June meeting the ECB was expected to set the stage for monetary policy normalisation which it has delivered in a number of ways. The ECB announced that APP purchases will be concluded as of 1 July 2022. The statement also laid out the path for policy rates, starting with a 25bp hike in July, followed by another hike in September, with the size of that rate increase depending on the updated medium-term inflation outlook. The path after that is expected to be “gradual but sustained”. The statement also reiterated strong commitment to adjusting PEPP reinvestments in the event of renewed market fragmentation but provided no detail on a potential spread management tool.

Continued upward surprises in European inflation and evidence of its persistence, as well as the Fed’s ‘hostile’ tightening path, are raising pressure on the ECB to frontload policy normalisation. While the risk of de-anchoring in longer-term inflation expectations does not seem high, rapid widening in policy differentials versus the Fed does present challenges for the ECB, with EURUSD re-pricing in the spotlight. But doing too much too soon would arguably be a riskier strategy for the ECB in light of a weakening growth backdrop as well as the risk of peripheral spread fragmentation.

The headwinds related to the war in Ukraine, China’s zero-covid policy and tightening in global financial conditions will continue weighing on the Eurozone’s growth, likely leading to a recession over the next few months. The timing and magnitude, however, largely depends on further developments in these three areas, as well as the  fiscal policy response to the energy shock. We believe it will be difficult for the ECB to execute a rapid return of policy rates into positive territory given the growth and fragmentation constraints and the tightening path will be less steep and shorter than what is currently implied by market pricing. While a new spread management tool might help prevent spread fragmentation, it will not be a silver bullet as will likely bring a new set of issues for the ECB, including moral hazard.”

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