(Bloomberg Opinion) -- There was a notable change of tone at Thursday's press conference from European Central bank President Christine Lagarde, but it's what she left out that was just as important. There was no repeat of the line that interest rate hikes are “very unlikely” this year. The tide is turning for Europe on having to confront rampant inflation.
As the ECB sees both near-term and longer out inflation risks rising, it is going to have to do something about it. Money markets are already pricing in 30 basis points of rate hikes this year. Bank of America Corp. and Commerzbank AG analysts are expecting two 25 basis point hikes in September and December which would return the ECB deposit rate to zero.
What really shook the ECB's thinking was Wednesday's euro area inflation for January, which missed expectations to the upside for the second month in a row. Core inflation was expected to fall sharply, as basis effects from Germany's sales-tax cuts from the pandemic finally passed through. But it is clear other segments are rising more than predicted to nullify that one-off downward impact. Unsurprisingly, the Governing Council had “unanimous concerns” over inflation and, according to sources quoted by Reuters, there was a sizable minority who wanted to change policy at the meeting.
The March 10 quarterly economic review is going to be a particularly interesting one because it will include what must be sharply higher inflation projections. First quarter headline CPI estimates may rise from the 4.1% predicted at the December review to over 5%. The Governing Council made clear, in post-meeting briefings, that a policy recalibration will be discussed then. That means a likely end to active monthly QE bond-buying in the third quarter. (Reinvestment will continue, as much as 450 billion euros this year.) The council also mentioned it was sensible not to exclude a rate hike this year. It has always made clear that rate hikes couldn't happen until QE programs ceased additions.
The euro put in a notably strong performance, reversing losses to the pound and swinging positive. That might seem unusual: the Bank of England actually raised rates Thursday while the ECB just dropped a couple of its more dovish qualifying phrases. However, contemplating an early end to the ECB's gargantuan monetary stimulus really is quite seismic. There are some of us who expected to end our careers without seeing a rise in the ECB deposit rate, let alone possibly turning positive.
Italian bonds reacted particularly badly, with 10-year yields rising over 20 basis points to levels not seen since the early days of the pandemic, although still well off the peak seen either then or during the 2018 political crisis. Italy's yield premium to Germany, the key measure of stress in the euro system, is at the widest for more than a year.
Negative rates really could someday come to an end in Europe as the global phenomenon of soaring energy prices, supply bottlenecks and other pandemic effects seep into secondary-order effects. Energy price jumps are just too big and persistent be ignored and allowed to pass through. Wage inflation may not be that visible yet but really it is coming and that surely will force the governing council's hand.
Lagarde made a half-hearted attempt to quell speculation by saying the ECB will not be rushed. But the complete change of pace from the BOE — which seems most likely to happen at the Fed, too, in March — is going to drag the ECB along whether it likes it or not. Markets have a momentum of their own and the ECB needs to get out ahead of it before it becomes an emergency. Its March meeting needs to address inflation head-on but the market has already made its mind up: at least one ECB rate hike this year and an early end perhaps by the summer to QE. Times really are a-changing.
More From This Writer and Others at Bloomberg Opinion:
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The Bank of England Wakes Up Hawkishly to Inflation Risks: Marcus Ashworth
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Fed Deals New York City, Los Angeles Another Setback: Conor Sen
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A Big Change Is Afoot. It's Not Just a Rate Hike: Daniel Moss
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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