Economics: Europe delivers a hawkish shift

We didn’t anticipate the ECB’s hawkish shift last week.

The ECB were clearly spooked by the surprisingly strong January inflation reading last week. Having so far pushed back against rate hike expectations, Mme Lagarde appeared to set up a more significant shift in tone at the March meeting.

But we still think markets are well ahead of themselves.

Still, we think current market pricing is well ahead of where it should be. For one, it seems inconsistent with the sequencing outlined by policymakers. And second, we still haven’t seen a robust wage response, despite improving labour market conditions.

Medium-term outlook likely to depend on wage developments.

If inflation remains high, a pick-up in wage growth could trigger an accelerated tightening timeline. But that’s not our base case. If inflation drops back as we expect, we think we’d have to see wage growth quickly exceed 3% to prompt a 2022 hike.