Diving in the alphabet soup

Key Points

• Although the market’s reaction was positive, the ECB’s press conference leaned to the hawkish side on substance. Yet, Lagarde’s openness to use an “anti-fragmentation” weapon is reassuring. We need to go back to 2012 to explore the possible avenues for the ECB on this matter.
• Core inflation surprised to the downside in the US in March. It’s too early to call for the inflation rollover though.

The market moderated its expectations for the ECB rate lift-off after Christine Lagarde’s press conference last week. True, instead of an acceleration in the termination of QE which some investors were fearing, the Governing Council chose to stick to the timeline sketched out last month. Still, we found the overall message rather hawkish: the central bank is visibly getting even more nervous about the risks of inflation persistence, and although Christine Lagarde expressed several times a willingness to be very cautious in the face of the uncertainty created by the war in Ukraine, overall it seems the ECB’s baseline is that the fallout should be manageable. The Governing Council also seems unimpressed by the tightening in financial conditions.

Yet, the bond market has welcome Christine Lagarde’s readiness to “design and deploy” anti-fragmentation weapons if and when necessary. She was remarkably guarded about the form that such programmes could take though. It’s understandable given the technical and technical difficulties already faced by the ECB in the past when designing tools to specifically address monetary policy transmission difficulties, while it was preparing to normalize its stance. We go back in time to 2010/2012 and the debates around the SMP and OMT. The latter - although never used – has been seen for 10 years as the “go to” anti-fragmentation weapon. It is cumbersome though, even if alternatives are not necessarily appealing.  We note however that there is an imbalance between what the ECB is being asked to do – create more Ptolemaic circles around its core missions to deal with every shortcoming of monetary union – and the contribution from national governments. In 2012, the solution to the sovereign crisis did not come from the ECB only, but also from the governments’ capacity to put together new frameworks, such as the ESM. We continue to think that without an extension of Next Generation EU, the ECB may be forced into “half solutions”, such as mobilizing the reinvestment from the QE programmes to support the most fragile signatures.

Meanwhile, the US dataflow has come up with a rare feat last week: core inflation rose less than expected last week. It’s too early to call the “inflation rollover” in the US though: the contribution from one single component (used cars) was essential. Yet, we continue to believe in a subsequent deceleration in consumer prices in the US which will allow the Fed to stop before reaching the levels seen in the “dot plot”.