The ECB’s Annual Meeting at Sintra

By:
Lukman Otunuga
Updated: Jun 27, 2022, 14:58 UTC

The prudently chosen words of central bankers have long influenced financial markets, and even more so since huge stimulus programmes have increased their clout and are now being wound down with interest rate hikes to the fore.

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All eyes on ECB Forum at Sintra

Written on 27/06/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

At various moments in history, leading central bankers have triggered significant price volatility and underlined the complicated relationship between the custodians of monetary policy and global markets.

So, when someone mentions ‘Sintra’, any trader worth his salt will recall the contribution of Mario Draghi a few years ago when central bankers gathered in Portugal to indicate that the era of quantitative easing might be coming to an end. ‘All the signs now point to a strengthening and broadening recovery in the euro area,’ Draghi said. ‘Deflationary forces have been replaced by reflationary ones.’

There were caveats of course, but the tone had been set with markets sensing exuberance as Draghi sounded positively bullish. A whipsaw in the euro and yields followed as traders thought the central bank would begin to phase out its crisis-era policies sooner than expected. The subsequent ECB meeting pressed ahead with plans to end its landmark QE programme when Draghi announced it would cut the size of its bond purchases, despite signs of a slowdown in growth.

Of course, we now preside over a very different economic landscape. Central bankers and the ECB are focused on elevated and sticky inflation which is forcing policymakers into a series of rate hikes. The worry is that this will ultimately contribute to an economic recession. Indeed, energy inflation in the eurozone is set to trend higher on squeezed gas supply and the Russian oil ban, which have both caused markets prices to increase again.

The most immediate issue for the ECB is also one peculiar to the region and its conglomeration of nation states. Financial market fragmentation is a key concern for President Lagarde when the central bank do kick off their interest rate rises as there is the potential for disorderly core-peripheral spread widening. This refers to instances where government bond yields in various parts of the eurozone rise at different speeds in response to higher central bank interest rates.

Bonds belonging to “core” nations like Germany would typically be expected to rise at a slower pace than the bonds in “peripheral” countries like Italy and Greece. This all means the cost to peripheral nations of higher ECB rates is greater and a concern is that the ECB could destabilise the region and be forced to abruptly halt their rate hiking cycle.

The issue was in fact so pressing that the ECB effectively scheduled an emergency meeting less than a week after its regular rendezvous to discuss market developments and in particular the widening of sovereign spreads. Certainly, the ECB is taking the situation seriously so does this mean we get more colour this week? Markets would especially want to know about conditionality on countries and the size of ECB purchases, among many other details.

What Can We Expect?

Perhaps it is too early to expect much from Lagarde and co over the next few days. It’s a hugely complicated subject that will most likely need to get passed by German courts too. We note that there is also a panel forum on Wednesday which includes the ECB President, the Governor of the Bank of England and Fed Chair Jerome Powell. Much chatter is expected here about fighting red-hot inflation while minimising the hit to economic growth. There is speculation about coordinated action too. Is there some volatility brewing once again in the Portuguese sunshine?

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About the Author

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets.

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