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ECB preview: a hawkish pause will satisfy hawks and doves

Bonds 3 minutes to read
Picture of Althea Spinozzi
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  At this week's ECB rate decision, policymakers will likely opt for a pause. Despite the hawks arguing that another hike is warranted, a recession is underway in their own countries. The doves will maintain that we are finally seeing rate hikes feeding through the economy and that overtightening risk is rising. Yet, for the ECB to keep its hawkish bias, policymakers might need to turn to the Pandemic Emergency Purchase Program (PEPP) and stop reinvestments. The PEPP program is half the size of the APP, and redemptions currently account for only 0.02% of its total holdings. Stopping reinvestments under the PEPP program will send a hawkish message without moving the needle much.


Economic data are screaming out loud stagflation for the Eurozone. The European Commission has cut the eurozone GDP for this year to 0.8% (prev. 1.1%) and 1.3% (prev. 1.6%) for 2024. Yet, inflation is poised to stay at 5.6% this year, while in 2024, it will drop to 2.9%, slightly higher than previously forecasted. In the meantime, confidence indicators are falling.

This week’s ECB monetary policy meeting will see the doves and the hawks fighting. Yet, it will come down to whether policymakers decide to tolerate negative growth surprises in Germany and the Netherlands. Indeed, the loudest hawks come from these countries, and the question is whether they will continue to support rate hikes while their economies are tumbling.

With the Federal Reserve having already delivered a successful hawkish pause, it might have arrived the time for the ECB to do the same. The biggest challenge will be for Lagarde to deliver a pause without sounding dovish. To do that, the central bank might need to look at its balance sheet and stop reinvestments under the Pandemic Emergency Purchase Program (PEPP).

Interest rate hikes are working

So far, the central bank has hiked by 425 basis points, bringing its deposit rate to 3.75%, just below market expectations of a 3.90% terminal rate. At this point, the ECB can claim that it has already done a lot and that rate hikes are slowly feeding through the economy, warranting a pause before deciding on another rate hike.

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PEPP: an opportunity for hawks and doves

The Pandemic Emergency Purchase Program (PEPP) represents an opportunity for hawks and doves. The PEPP program is half the size of the APP, and redemptions currently account for only 0.02% of the PEPP total holdings. Stopping reinvestments under the PEPP program will send a hawkish message without moving the needle.

While under the quantitative tightening program (QT), the ECB stopped reinvestments under the asset purchase program (APP), reinvestments under the PEPP continued. The average weighted maturity of bonds under the 1.6 trillion PEPP program is above seven years. Therefore, the current volume of redemptions is minimal, with the latest quarter-end redemptions amounting only to 3 billion (roughly 0.2% of the total holdings under the PEPP). Although stopping reinvestments under the PEPP might not add pressure to rates in the short term, it will help the ECB to deliver a hawkish message amid a dovish decision. Tweaking further disinvestments under the 3.135 trillion APP program instead might cause volatility in bond markets.

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Source: Bloomberg.

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