ECB backs end of easy money

This is the end of an era for the bond market. It’s easy and cheap money. Following the exceptional move of the Governing Council to Amsterdam, the European Central Bank confirmed that it will stop providing liquidity to the market, as it has done since 2015, from 1uh July. And that she will raise rates twice, in July and September.

The termination of the asset purchase program, known as the APP (Asset Purchase Program), did not come as a surprise. This was announced in February. It then gained legitimacy as eurozone inflation set new records. It reached 8.1% (yoy) in May and new ECB expectations predict it will still hover around 3.5% in 2023 (before falling to 2.1% in 2024).

Created in 2015 to combat the specter of deflation, APP no longer has a place during times of price spikes. “We must stay the course and be determined to contain inflation,” confirmed central bank president Christine Lagarde.

The cessation of net purchases of government and corporate debt securities (payments on maturing securities will continue to be reinvested) has at least two consequences. First, the bond market will have to learn to live without ECB support. In June, another 20 billion euros were invested, an amount that has already fallen since the beginning of the year (40 billion in January). This manna made it possible to maintain very favorable financing conditions for the eurozone states.

First rate hike in July

The halt to purchases then opens the door, according to a scenario set by the ECB itself, to the first hike in key rates since 2011. The Frankfurt Institute confirmed that the initial 25 bps increase was due from July. An unusual commitment in a world of central banking that favors ambiguity. Christine Lagarde even explained that it was “the beginning of the journey” towards the end of the emergency measures in place since 2015.

The French have confirmed that there will be a new rise in September and that this second turn of the screw may be more important. Because if Christine Lagarde called it “good practice” an initial 25 basis point hike, a move also defended by ECB chief economist Philip Lane, she confirmed that the ECB is ready to hit harder as follows. “The increase in key interest rates scheduled for September may be more significant [que 25 pb] if the inflation forecast [de la BCE] for 2024 are equal to or exceed 2.1%,” the president decided.

The path to normalization

“The road to normalization will not stop in September,” ING’s Carsten Brzeski warns. True, Christine Lagarde assured that the rate increase would be gradual. “But,” emphasizes Frédéric Ducrose of Pictet, “she specified that the pace would be gradual and sustained.

In other words, the Board of Governors can decide to raise the rate at each of its four meetings between today and December. Assuming a 50 bps increase in September, the deposit rate will rise to 0.75% in December, the highest level since July 2011.

Clarifications awaited

The ECB president has been more evasive about the means the ECB intends to use to prevent monetary tightening from causing a “fragmentation” of the eurozone. In other words, an increase in the difference in the cost of borrowing between different countries, which could lead to a new euro crisis.

“When necessary, as we have convincingly demonstrated in the past, we will use existing tools or new tools. We are committed – committed! – communicate our monetary policy correctly,” she said.

Words alone were not enough to calm the markets. The Italian 10-year rate jumped 25 basis points to 3.61%, while its German equivalent rose only 9 basis points. The spread between them reached 218 basis points, the highest in more than two years. “As the reaction of the bond markets to the press release and press conference shows, the ECB appears ‘disarmed’ in the face of spread tensions,” Aurel BGC concludes.

French 10 year old exceeds 2%

The French 10-year rate jumped nearly 13 basis points in the session, topping 2% for the first time in more than eight years. It was still hovering at 0.20% at the beginning of the year.