Daniele Antonucci, chief economist and macro strategist,
Quintet Private Bank
Our outlook on euro area economic growth is more bearish than the ECB’s and we think the probability of recession over the next 12 months, while not our base case, is higher. This is due to the euro area’s high exposure to Russia/Ukraine and its impact on commodities and supply chains.
One downside risk, therefore, is that this policy tightening cycle, after the first few hikes, comes when the economy is weakening rapidly and, possibly, inflation may be turning from high levels. Another risk is the possible return of political risk premium and debt sustainability issues in Italy with, potentially, some contagion to other vulnerable members of the monetary union.
This is why we expect fewer hikes than priced by markets currently. Also, investors will be watching whether the ECB’s “anti-fragmentation” tools, including an adjustment to reinvestments and new pandemic purchases in case of yet another virus outbreak, are effective at containing these risks.
Seema Shah, chief strategist, Principal Global
The ECB has never provided clearer forward guidance than they did today [yesterday], signalling that a 0.50 per cent policy rate increase is likely unless inflation pressures subside. With energy prices, if anything, on an upward path and supply chain concerns unlikely to ease in the near future, inflation pressures will not be eroded quickly.
With this inflation outlook and the unavoidable path for higher rates, the ECB is facing stagflation threats full-frontal. The stranglehold of desperately high living costs means that the euro area growth will slow through the second half of this year, with recession increasingly likely – particularly now with sharp policy tightening in the near-term horizon.
The key beneficiary is the euro. The reversal in US and eurozone market interest rate expectations, with peak Fed expectations now likely behind us and ECB rate expectations rapidly moving higher, is challenging the strong dollar and a rally in the euro is in sight.
Anna Stupnytska, Fidelity
Continued upward surprises in European inflation and evidence of its persistence, as well as the Fed's “hostile” tightening path, are raising pressure on the ECB to frontload policy normalisation. While the risk of de-anchoring in longer-term inflation expectations does not seem high, rapid widening in policy differentials versus the Fed does present challenges for the ECB, with euro/dollar re-pricing in the spotlight. But doing too much too soon would arguably be a riskier strategy for the ECB in light of a weakening growth backdrop as well as the risk of peripheral spread fragmentation.
The headwinds related to the war in Ukraine, China's zero-Covid policy and tightening in global financial conditions will continue weighing on the eurozone’s growth, are likely to lead to a recession over the next few months. The timing and magnitude, however, largely depends on further developments in these three areas, as well as the fiscal policy response to the energy shock.
We believe it will be difficult for the ECB to execute a rapid return of policy rates into positive territory given the growth and fragmentation constraints and the tightening path will be less steep and shorter than what is currently implied by market pricing. While a new spread management tool might help prevent spread fragmentation, it will not be a silver bullet as it is likely to bring a new set of issues for the ECB, including moral hazard.