February ECB meeting: A reinforced commitment to price stability

Today, the European Central Bank (ECB) again raised its three key policy rates by 50 basis points (bps), but also surprised markets by stating its intention to raise another 50 bps in March—effectively announcing a 1% hike across two meetings. The interest rate on the main refinancing operations, the marginal lending facility, and the deposit facility will be increased to 3.00%, 3.25% and 2.50% respectively. With 300 bps of rate hikes since last July, and the stated intention of another 50 bps hike in March, the ECB’s goal remains one of dampening demand and guarding against the risk of a persistent upward shift in inflation expectations.

The ECB’s latest projections from December indicated that inflation will still be above the ECB’s 2% target at the end of their forecast period, implying that further rate hikes were clearly required. Today, the ECB reiterated its December principles for balance sheet normalization (known as Quantitative Tightening, or QT). From March 2023, the asset purchase programme (APP) portfolio will decline by an average of €15bn per month until the end of June. Decisions about further declines will be determined thereafter. There were no announced changes to the bank’s other lending programs.

The ECB did also emphasize its intention to tilt corporate bond purchases more strongly towards issuers with a better climate performance, and that it is supportive of “the gradual decarbonization of the Eurosystem’s corporate bond holdings, in line with the goals of the (2015) Paris Agreement.”

Data departure

In a rare departure from inter-meeting data dependency, it appears as though the ECB has seen sufficient inflationary concerns to pre-announce its policy intentions for the March meeting. While euro area annual headline inflation has recently begun to abate from its October high, core inflation continues its ascent and remains at record highs (now 5.2%). The prior year’s surge in energy costs is still spreading throughout the economy, and other underlying inflation measures are also still high. Given core inflation’s persistence and pervasiveness, the euro area still needs additional tightening to bring inflation back towards the 2% target.

Eurozone inflation
Monetary Union Index of Consumer Prices, 2004–present

Staying the course

The statement said the ECB Council “will stay the course in raising interest rates significantly at a steady pace and in keeping them at levels that are sufficiently restrictive...” While a March step-down has been ruled out for now, the market is currently pricing in a peak (deposit facility) terminal rate of over 3.25%. This incorporates the stated March 50 bps hike, plus another 25 bps in May, with the possibility that May could bring another 50 bps. By removing the possibility of a March step-down in the rate of hikes, the ECB has laid out its firmly hawkish stance and its commitment to “staying the course.”

In contrast to the ECB, the United States Federal Reserve has continued slowing the pace of its rate hikes, raising policy rates just 25 bps at its latest meeting. This has been a tailwind to the euro, which is up 14.5% since a late September low. This appreciation is contributing to tightening financial conditions in Europe, as well as dampening import inflation effects—both welcome developments for the ECB to achieve its inflation goals

As future rate hikes have already been affirmed, the ECB has removed any doubt of its commitment to the price stability mandate. Economic uncertainty remains abound for the region, and policymakers must surmount a complex balancing act between weak growth, persistent inflation and external international shocks. While the 4Q22 risk of recession appears to have been avoided, downside growth risks remain. If the current economic slowdown does later result in recession, this could impede the ECB in arresting its hiking cycle before it has effectively seen inflation return to target.