Rates Spark: The gloves are off

The ECB pre-meeting quiet period, starting yesterday, has not stopped hawks and doves from fighting, but the debate has moved to anonymous comments in the press. The various reports are contradictory in some places, and they paint a picture of a divided ECB. It is difficult to conclude where consensus will eventually land, but at least, the battle lines are drawn. What they seem to agree on is that PEPP net purchases should come to an end, as planned in March 2022. There is also a sense that the ECB will shy away from long-term commitments.

PEPP net purchases should come to an end as planned in March 2022

In the dovish corner, members seem to favour a temporary increase in purchases of either the APP, or another temporary programme, once PEPP net purchases draw to a close at the end of March 2022. The sources quoted by Reuters seem to favour keeping as many options open as possible, but in any case, prefer not to make any commitment to buy after 2022 due to the upside inflation risk.

In the hawkish corner, members have argued in favour of allowing PEPP to deploy its unused firepower after March 2022, and to allow more flexibility in reinvestments after that date. The sources quoted by Bloomberg also stressed that extending the reinvestment period could soften the blow for financial markets.

We doubt that the hawks' package would be sufficient to calm markets’ craving for asset purchases and, as a result, our economics team thinks that the ECB will manage the transitions from PEPP with a €300bn programme endowed with the same flexibility as PEPP.

We think this decision would rightly be perceived as dovish by rates markets, helping stabilise core and peripheral yields around their current levels, or tighter, into the end of the year. This also seems to be the majority view of economists surveyed by Bloomberg, favouring a temporary increase in the APP after March rather than an abrupt drop in total net purchases.

Markets may well adjust to a world without QE

This may only be a temporary state of play, however. If the ECB forecasts inflation hovering around its 2% target in the coming years, markets will conclude that they may well adjust to a world without QE, as is already the case in the UK, and soon will be the case in the US. This receding tide of liquidity is one of the key themes we identified in our 2022 Rates Outlook. This means generally higher rates, but things will be complicated by a reduction in supply and already hawkish market pricing in some places.