Thursday, February 2, 2023

Daily Market Overview

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• The ECB raised its key policy rates as expected by 50 bps with the deposit rate now reaching 2.5%. In its statement, the central bank says that it intends to raise rates by another 50 bps in March. The ECB vows to stay the course in raising interest rates and to keep them at restrictive levels for long enough to ensure a timely return to the 2% target. The only addition compared to December was that the subsequent path of monetary policy will be evaluated in March when new projections are available. Following yesterday’s FOMC meeting and the BoE meeting earlier today (see below), markets interpreted this guidance as preparing for a potential pause as well. ECB Lagarde in an initially messy press conference tried to convince markets from the opposite. “No, no, no” when it comes to the peak in March, “we shall not be doubted” in reaching a policy rate restrictive enough to push inflation down, “we shall not be doubted” in our commitment to keeping rates there and “there is quite some ground to cover”. Lagarde especially stressed rising indicators of core inflation. Risks around the economic and inflation outlook have become more balanced compared with the previous meeting, but as regard to inflation remain tilted to the upside. The market reaction was a vote of no confidence. European money markets lowered their expectations around the peak policy rate from 3.5% to 3.25% (ie one final 25 bps hike in May) in a parallel shift lower across the curve. The end of 2024 policy rate expectation is now 2.50% instead of 2.75%. German yields drop 11.5 bps to 20.2 bps with the belly of the curve outperforming the wings. 10-yr yield spreads vs Germany narrowed by up to 5 bps with Italy (-13 bps) outperforming. European stock markets built on their opening gains (reaction to WS yesterday) with main benchmarks currently gaining up to 2%. The loss of interest rate support (US yields slide around 5 bps) pulls EUR/USD away from the 1.10 zone and back below 1.0950. We expected/hoped that market expectations would shift towards central bank talk (our main scenario) after the first policy meetings of the year. Especially in the case of Europe, we are flabbergasted that exactly the opposite occurred. Despite a vivid defense (compared to the lackluster composure of Fed Chair Powell), we notice that the stretch between the both even became larger. We acknowledge market momentum, but fear that markets are way too complacent when it comes to the central bank’s reaction function.
News & Views

The Bank of England as expected raised the base rate by 50 bps to 4.0%. The vote was 7-2, as two members preferred to keep the policy rate unchanged at 3.5%. The BoE acknowledges that domestic inflationary pressures have been firmer than expected, mainly due to higher private sector pay growth and persistent services inflation. Even so, the central bank is flagging a data-dependent approach going forward as inflation is expected to fall sharply from 10.5% in December to around 4.0% end this year. The BoE’s model forecast (conditioned on a market-implied path of interest rates) expects inflation to fall back below 2% in the medium term, but there are big uncertainties and upside risks to this forecast. The BOE expects output to fall below potential by early next year. If there were to be evidence of more persistent pressures, further tightening be required. The door is open to a pause in March, but this is highly conditional. In a first market reaction, markets see a 75% change of a final rate hike in March. At the same time, pricing is discounting a rate cut by the end of the year. UK yields nosedive between 20 bps (5-10y and 15 bps (30-y). Sterling trades in the defensive, especially gains the euro. EUR/GBP temporary moved above 0.89 resistance before returning towards 0.8885 during Lagarde’s Q&A session.
• The Czech National Bank today kept its policy rate unchanged at 7% as was widely expected by markets. After starting a hiking cycle from a bottom of 0.25% in June 2021, the CNB kept rates stable since June of last year. In a first brief statement after the decision, the CNB reiterated that it will continue to prevent excessive fluctuations of the koruna exchange rate. An in extenso statement will be published after finishing this report together with a CNB press address. EUR/CZK is trading little changed near 23.78.

Graphs & Table

EUR/GBP briefly jumps north of 0.89 on ‘soft’ BoE, but returns back lower during the ECB press conference

German 2-y yield nosedives even as ECB indicates to hold course.

EUR/USD returns towards 1.09 as single currency loses interest rate support

German/Italian 10y yield spread: BTP’s rallying as markets downscale further tightening

Note: All times and dates are CET. More reports are available at which you may sign up to.

This document has been prepared by the KBC Economics Markets desk and has not been produced by the Research department. The desk consists of Mathias Van der Jeugt, Peter Wuyts and Mathias Janssens, analists at KBC Bank N.V., which is regulated by the Financial Services and Markets Authority (FSMA). Read the full disclaimer.

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