ECB hikes 50 bps with more to come

As expected, we got another 50bp hike from the ECB. On top of that, Lagarde revealed an intention to do another 50bp hike in March. The Governing Counsel maintained its language to raise rates “significantly”, “at a steady pace” and “keeping interest rates at restrictive levels”. So one would be forgiven for thinking the ECB was still on a hawkish trajectory. Markets thought otherwise, reacting as if the ECB had just announced rate cuts, with euro-area bonds rallying hard and the euro weakening.

Clearly the market is desperate for a sign that the ECB will soon start slowing the pace of tightening, so part of the dovish reaction may come down to positioning. Lagarde describing inflation and growth risks as becoming more balanced will have also given confidence to bond investors. Nevertheless, this rally does look premature; headline inflation remains a long way from target, core inflation has yet to see any meaningful reduction, and, as we recently saw from Spain, core inflation can still surprise to the upside.

Not much more to add on European QT from what we already heard in the December meeting, other than reinvestments will be broadly proportional across APP portfolios and the ECB’s corporate bond portfolio (CSPP) reinvestments will be tilted towards issuers with a better climate credentials. How these credentials will be defined is still unclear as this is going to be driven by a mix of measures, ranging from absolute emissions to good disclosure practices. I suspect investors will be laser-focused on which bonds are bought and sold by the ECB each week to figure out who is on the naughty list.