Market Update: ECB pushes ahead with a first rate hike, doesn’t alter market expectations for more to follow

Highlights: The European Central Bank (ECB) delivered a first 25bps policy rate hike in over two years (deposit rate to 2.25 per cent), becoming the first major central bank to act directly on the impact of the energy supply disruption. To move was fully priced-in with traders focusing on any forward guidance. ECB President Lagarde said the rate hike was “robust” across economic scenarios but declined to endorse the move as the start of a new rate hiking cycle. We expect two additional rate hikes this year, but not an aggressive tightening cycle. With those additional hikes already reflected in market pricing as well, we keep a neutral view on EUR and most Eurozone equity markets, preferring structural thematic exposures and EUR IG quality bonds.

• ECB President Lagarde said today’s rate hike decision was robust across scenarios and dismissed its characterisation as a “pre-emptive” or “insurance” one, when questioned. Policymakers now expect more acute price pressures and slightly weaker growth under the baseline scenario, with inflation returning to the 2 per cent target in H2 2027. However, with “most long-term inflation expectations” well-behaved and risks to economic growth increasing, we think the ECB will not onboard an aggressive tightening cycle, and the hikes are likely to be reversed next year
• Market action has largely been dictated by global risk developments rather than the ECB meeting, with the rate hike decision being broadly expected and the guidance doing little to shift market expectations. Derivatives markets continue to price in two additional rate hikes by the ECB but have brought forward the timing to before year-end. EUR performance was mixed with losses against a stronger dollar, but gains versus the sterling, driven by domestic developments the latter two. European bonds and equities rallied since the start of the session benefiting from lower oil prices and the broader risk-on sentiment
• EUR has remained supported by global risk appetite in recent months, and while our year-end target at 1.18 remains plausible, we think that downside risks to that view have been increasing, and we keep a neutral view on the single currency. Eurozone equities face a challenging mix of slowing domestic growth and external risks to trade, but we see opportunities in our favoured sectorial exposures. With the ECB expected to deliver further rate hikes this year, we see little scope for capital gains on European sovereign bonds but seek to clip more attractive coupons from medium-to-long duration quality IG bonds where we have a mild overweight