The European Central Bank (ECB) raised its key interest rates on Thursday by 50 basis points as expected and flagged another 50bp hike in March. Despite such decisions and Lagarde’s hawkish comments, European bond yields tumbled. Analysts at Rabobank point out the central bank continues to struggle with its image and credibility. They expect a 50bp hike in March, followed by two 25bp hikes in Q2 to a terminal rate of 3.50%.
Markets ran away with the few dovish parts of the announcement
“The ECB continues to struggle with its credibility issues ever since it started playing fast and loose with forward guidance. Despite an overall hawkish hike, markets largely ignored Lagarde’s attempts to clarify the ECB’s reaction function. Underlying inflation is “alive and kicking”, and the ECB will stay the course until there are convincing signs that inflation will converge back to the 2% target. We don’t think that the ECB gets this proof before summer, and we’ve accordingly increased our terminal rate forecast to 3.50%.”
“Despite the market not buying Lagarde’s message, we will bite. We have revised up our rate forecasts significantly to a 3.5% terminal rate. However, that is clearly a restrictive level that cannot be sustained by the Eurozone economy. We have pencilled in a first cut in 2024H2.”
