The ECB weighed on the mood in the financial markets on Thursday. Faced with the impressive rise in monetary union inflation, it opened the door to prolonged action on the front of its key interest rates, considering that regular rises would be necessary to bring inflation back to its 2% target. The Eurozone Monetary Authority now predicts inflation of 3.5% in 2023 and 2.1% in 2024. “The forecast for long-term inflation above 2% is unprecedented and reflects a major shift within the ECB,” stresses management company Candriam.
The change of direction “is well and truly registered”, adds Véronique Riches-Flores, founder of RF Research. As Christine Lagarde explained to the press, “it is not just a matter of a step taken, but of a long journey in which the ECB will raise its interest rates as much as it takes to bring inflation back there. Where its mandate limits it “, emphasizes the expert. The ECB “signs the end of negative interest rates and the start of a gradual and long-term path”, warns Candriam, for whom starting the normalization process at this stage of the cycle is “a real challenge”. Less liquidity, fewer bond purchases and higher interest rates “make up a perfect cocktail for a summer that is set to get very hot”, according to the financial establishment, which considers “it is important to remain selective and flexible” in such an environment.
In response to the ECB’s comments, expectations of interest rate hikes rose, leading to a brutal reaction from the debt markets. France’s 10-year interest rate rose to 2%, while Italy jumped to 3.73%, bringing the spread with the European benchmark (the German bottom) to more than 2%, 3 percentage points. A phenomenon that risks ending up reviving fears of eurozone public debt in the medium term. The end of quantitative easing (massive bond purchases from the ECB, editor’s note) poses a “clear threat to financial stability”, warns Candriam, especially since “even though markets are considering implementing supervision of spreads (interest rate differentials between euro area member states, editor’s note), no further tool has yet been presented ”. While the risk of fragmentation within the euro area is considered “significant”, “there is no doubt that in the coming months the ECB should announce the implementation of a new tool in the coming months” for the Management Company.
Christine Lagarde “begins a radical change of attitude, which should convince of a major break with the past”, assesses RF Research, for whom the consequences of this change of course are of course very uncertain. “In the short term, there is no doubt that interest rate tensions will intensify as international conditions continue to fuel the prospect of a sustained rise in inflation,” according to the research office.
While maintaining the Fed’s restrictive course across the Atlantic is currently the key scenario, “an upward escalation of expectations of monetary tightening seems like an obvious risk”, warns RF Research, for whom it now seems desirable to “keep away from the most vulnerable” markets, whether public or private debt (corporate bonds), where “the double shock of a halt in the ECB’s purchases (of assets) and the rise in interest rates suggest significant consequences”.
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Author’s declaration of interest