- First rate hike since 2011: Given the challenging macro backdrop the unwinding of monetary stimulus will proceed at a gradual pace at best in 2019. Assuming that the economic upswing in the Eurozone remains intact next year, as is plausible from today’s point of view, the ECB will raise rates for the first time since 2011 starting off with a 15bp hike in the deposit rate in September followed by a 25bp hike in all key rates in December. This will also reflect an attempt to win back policy room to fight the next crisis.
- Safety nets to ensure a smooth departure from the zero lower bound: For the great unwind to proceed without any tantrums, the ECB will put safety nets in place. For one the reinvestment of maturing bonds will weigh on long-term rates until at least 2021. In addition the ECB is likely to extend its forward guidance beyond the first rate hike to ensure that market expectations remain aligned with its monetary policy intentions.
- Banks receive a helping hand: The ECB will likely announce a new round of TLTRO funding in Q1 2019 to support lending conditions at a time when confidence in the Eurozone banking sector is waning. To address the risk of Eurozone banks becoming too dependent on cheap loans, the ECB could announce a floating-rate TLTRO to ensure that any rate hikes are passed through to banks.
- Country risk is staging a comeback: As the ECB gradually pulls back, the role of market discipline will strengthen again. Investors will increasingly differentiate between countries with strong economic fundamentals and more fragile ones. Meanwhile sound policy-making will be rewarded while the room for policy mistakes will start to disappear.