Sharp Market Rates Repricing Could Leave Thursday’s ECB Projections Looking Outdated

14 March 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – Markets’ sudden slashing of their expectations of the European Central Bank’s terminal rate by over 75bp in the wake of the Silicon Valley Bank insolvency could have significant implications for the ECB’s macroeconomic projections, due to be released on Thursday.

The projections are calculated using a series of ‘technical assumptions’ about interest rates and commodity prices that are based on market expectations, usually as of a couple of weeks before the updated forecasts are published.

The ECB declined to reveal the cut-off date for Thursday’s projections, noting in response to a request from Econostream on Monday for this information that it would be published together with the forecasts. Recent history, however, would suggest that – barring a sharp reversal of the latest market moves – the rate hike path used to calculate the ECB’s forecasts will be hopelessly outdated by the time the latter are released.

Looking at recent projections, the cut-off date for the last exercise in December was 22 days before release, whilst the September forecasts were based on market pricing from 17 days previously.

The only example from recent memory when the ECB adjusted its forecast exercise to take into account last-minute developments was in the wake of Russia’s invasion of Ukraine in February of last year. In order to capture the initial impacts of the invasion, the ECB’s forecasters adjusted the window during which futures prices were averaged from ten to three days, covering only the period since the start of the invasion.

Following the failure of Silicon Valley Bank over the weekend, market expectations of the ECB’s terminal rate saw a significant repricing on Monday, falling over 75bp. The November 2023 ECB Euro short-term rate (€STR) Forward dropped to 3.18% from around 3.95% last Thursday.

ECB Chief Economist Philip Lane recently said that ‘if you look further, to 2024, to 2025, the tightening of monetary policy has been significantly more than what was baked into the December forecast and that has to be factored into the new forecasts.’

His comments imply that Thursday’s numbers would show lower headline inflation in the medium-term, due to, amongst other things, markets anticipating more ECB tightening than they did in December. Now that markets have reversed a large portion of these increased expectations, the assumptions that have been baked into the new forecasts – the ones that Lane was referring to – no longer stand up.