ECB: Monetary versus geopolitical policy, between hammer and anvil

The eagerly awaited meeting of the European Central Bank (ECB) has taken place. The key interest rates remained unchanged. The bond-buying program is to be reduced more quickly than previously expected by the third quarter. The ECB is distancing itself from lower interest rates in the future. However, an interest rate increase is not envisaged for the time being.

The ECB is the first major central bank to hold its meeting after Russia's invasion of Ukraine. It was therefore eagerly awaited.

Key statements on monetary policy from the ECB meeting on 10.03.2022

• The ECB is the first major central bank to hold its meeting after Russia's invasion of Ukraine. It was therefore eagerly awaited.
• Interest rates remain unchanged: Deposit rate -0.5% and refinancing rate 0.0%.
• The bond purchase program (APP) is to be reduced in €10 billion steps until the third quarter (April €40 billion, May €30 billion, June €20 billion) and adjusted thereafter depending on data.
• The statement of a subsequent interest rate hike soon after the end of the program is being refrained from. The market expects a first interest rate step in July at the earliest.
• The PEPP pandemic package expires at the end of March, but can be reinstated if needed.
• The repo facility (EUREP) related to the COVID-19 crisis in favor of central banks outside the euro area will remain in place until January 2023.

Statements on the geopolitical situation and its impact on the ECB's monetary policy

The invasion of Russian troops in Ukraine represents a turning point for Europe. The peace premium will fall away and inflation will experience an additional boost. However, interest rate steps will only be gradual and will only start some time after the end of bond purchases. Sufficient liquidity will be provided for Ukraine.

The APP will be gradually reduced by the third quarter. Expiring assets are expected to be fully reinvested by the end of 2024. The ECB's balance sheet total will therefore no longer grow from the third quarter onward - but it will not shrink either.

The third series of favorable lending conditions to banks (TLTRO III) is scheduled to end in June 2022 and will not affect the restructuring of monetary policy measures. The measures started in 2014 and enabled banks to borrow cheaply from the ECB.

The Governing Council reaffirms to take all necessary measures to stabilize the medium-term inflation target at 2%.

This formulation and the measures taken today seem rather cynical with inflation for the Eurozone currently above 5% and a significantly increased inflation forecast to 5.1% for 2022.

Reaction of the financial markets

The European stock markets are taking Ms. Lagarde's statements relatively calmly. However, the more significant decisions for the stock markets in the short term will be made between the two warring parties. The rapid end of the talks between the two foreign ministers Laworw and Kuleba in Antalya last week dampened hopes for a rapid rapprochement and weighed on the markets.

However, the interest rate markets reacted strongly to the ECB's news. Interest rates on 10-year government bonds for Germany rose by around 10 basis points and those for Italy, Greece and Spain by 20 r15 and 10 basis points. The price on the 10-year German Bund fell by around 1% - the 10-year Italian Buoni by 2%.

Expectations for the FED meeting on 16.03.2022

Much more is expected from the U.S. Federal Reserve this week than from the ECB. The bond-buying program is likely to be terminated and a first tentative interest rate step is expected. Inflation is higher than in Europe today at around 7.9%, but future pressure is likely to be less strong than in Europe due to the geographical distance from the trouble spot.

Fed fund futures, which reflect the expectations of financial market participants, imply a first rate hike of 25 basis points in March followed by further rate hikes of 1.75% (to 2%) by the end of the year. As of today, interest rates on 10-year U.S. government bonds are at this level.

It can be expected that the Fed will deliver what the market expects and that the markets will react relatively unspectacularly. The changes in the Fed's wording are unpredictable.

Bonds further underweighted

We therefore remain underweighted in the bond ratio. In the short term, the pressure on yields is likely to persist due to the inflation trend. However, if credit spreads on high-quality corporate bonds (investment grade) continue to rise, buying opportunities could soon open up here.

Contact: Christoph Sieger, Portfolio Manager
Telephone: +41 58 680 60 56

Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.

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