Four Things Traders Will Be Watching For From The ECB Today

By Ven Ram, Bloomberg markets reporter and analyst

Here’s what rates and currency traders will be riveted on when the European Central bank unveils its policy review today (full preview here):

1. Margin of hike: A majority of economists polled by Bloomberg forecast a 75-basis point move today, with some expecting a 50-basis point increase. Overnight indexed swaps, which couldn’t quite make up their mind as of the close of trading Wednesday, are now pricing in about 89% chance of a 75-basis points move.

A determined path of monetary policy should respond more forcefully to the current bout of inflation even at the risk of lower growth and higher unemployment, European Central Bank Governing Council member Isabel Schnabel said at last month’s Jackson Hole symposium. While chief economist Philip Lane seemed to advocate a more measured approach by arguing that macroeconomic expectations suggest a high degree of concern about a potential slowdown, he conceded that “the right tail of responses in expert and household surveys also clearly show that the risk of inflation not returning to target in a timely manner.” That concern about inflation expectations may carry the day for the ECB, with forward inflation pricing proving to be sticky since the last meeting on July 21. The ECB’s own survey on inflation showed that the median expectation for three years ahead rose to 3% in July from 2.8%, paving the way for the hawks within the council to take charge of the narrative.

2. Forecasts, forecasts: Given the energy shock and all else that is holding down sentiment in the euro area, the ECB is most likely to revise down its economic growth forecasts. The monetary authority forecast real GDP growth of 2.1% for 2023 back in June, though Bloomberg Economics now estimates a recession over the fourth quarter of this year and the first quarter of next.

It is also likely that the ECB will revise up its inflation forecasts for both next year from 3.5% and for 2024 from 2.1%, though the question will come down to how much and what that would entail for the ECB’s benchmark rate. Front-end German rates, which were in denial about the ECB’s trajectory for much of the initial summer, have since sat up and taken notice. A hawkish turn of events today will entrench the recent despondency in two-year German notes.

3. Transmission Protection Instrument: The ECB couldn’t have coined a worse abbreviation even if it tried, but we are stuck with it for now, and President Christine Lagarde may be asked about any progress on the instrument. Thankfully for the ECB, though, yields have been well-behaved since its previous review. For instance, the 10-year Italian yield has climbed some 30 basis points since July 21, those in Spain and Portugal by about 25 basis points apiece. The ECB will take that kind of volatility, especially when you consider that 10-year US yields have climbed by about 35 basis points over the same period.

4. Euro: The euro has lost some 2% since the ECB last met, so much so that it is now trading around parity, which will no doubt result in some questions to Lagarde during her post-meeting review. The ECB’s own nominal euro effective exchange rate has declined less visibly over the same period. Lagarde will note that the euro is just one of many variables the ECB monitors and that the monetary authority is closely tracking the euro’s fortunes. To the extent that a weaker euro tends to import inflation into the region, the ECB is unlikely to welcome outright declines in the euro with open arms.