MUFG’s Lee Hardman notes that unwanted tightening in Euro-zone financial conditions is prompting markets to pare back expectations for further ECB rate hikes. Pricing has shifted closer to MUFG’s forecast of two additional moves, which may still be too aggressive if fragmentation risks intensify, while speculation grows that the ECB could slow QT or activate its Transmission Protection Instrument.

Tightening conditions challenge ECB path

“The unwanted tightening in financial conditions has already encouraged market participants to scale back expectations for further ECB rate hikes in response to the energy price shock.”

“Market pricing for ECB hikes has moved more in line with our own forecast for two further hikes which could still prove too aggressive if the re-emergence of fragmentation risks intensify.”

“There is also building speculation that the ECB may have to take further policy action to ease contagion risks by slowing down QT, and/or even utilizing their Transmission Protection Instrument (TPI) for the first time.”

“However, a decision to utilize the TPI would create the impression that the ECB is helping governments to finance their deficits.”

“As such, the ECB would only decide to purchase government bonds through the TPI if the purchases are temporary, and governments take action as well to tighten fiscal policy to restore investor confidence.”