The European Central Bank is set to make headlines again on Thursday as it is widely expected to raise its benchmark interest rates by another 25 basis points. The financial world is keenly watching to gauge the ECB’s plans for September and beyond.
While most analysts believe rates are nearing their peak, AllianzGI warns of potential further increases due to persistent inflation, asserting that “the ECB cannot compromise and must continue to tighten financial conditions.” Berenberg can’t exclude that the ECB will hike rates again in October or December, if not in September.
For Thursday, the consensus is that the ECB will hike the deposit rate to 3.75% as anticipated. The focus clearly is on what the ECB will decide at its next policy meetings. Some hawkish members have expressed caution about the post-July period. Klaas Knot, the head of the Dutch central bank and known as one of the most hawkish ECB council members, has acknowledged the necessity of a July hike but downplayed the certainty of further increases.
The upward revision of inflation projections announced by the ECB in June supports the case for further rate increases. ECB President Christine Lagarde has mentioned that the inflation process’s second phase is becoming stronger due to a sustained wage catch-up process, keeping inflationary pressures in check. The tight labour market is also contributing to this phenomenon.
Analysts expect Lagarde to be more nuanced in her remarks about future meetings, emphasising data dependence and the importance of the staff projections to be published in September.
Pictet sees rate peak at 4%
“A September hike is not a done deal,” said Nadia Gharbi, senior economist at Pictet Wealth Management. “Either way, we believe that a September hike would be the last one in this cycle, bringing the deposit rate to 4%. Crucially, the ECB will then focus on the necessity to keep rates at these levels for longer, and we expect no rate cut before H2 2024.”
State Street: September hike not unreasonable
At State Street Global Advisors, senior investment manager Des Lawrence noted that wage pressure has become an increasingly important source of inflation. This, he said, has raised the likelihood of a further rate hike in September.
“We would not regard a further 25 basis point rate hike at the September meeting as unreasonable given those remarks and inflation backdrop,” Lawrence said. “Beyond that we think there’s a good case in favour of holding policy rates steady at those levels for some time.”
Pimco: no cuts before year-end
Konstantin Veit, portfolio manager at Pimco, said the currently priced terminal rate of 3.95% is “reasonable” and reflects expectations of another 20 basis point increase in ECB rates beyond July. Rate cuts then could begin during the first quarter of 2024. “We remain doubtful that the ECB will implement rate cuts as early as projected, given the persistent nature of underlying inflation,” Veit said, referring to some market expectations of cuts before the year-end.
Monex sees terminal rate at 3.75%
Simon Harvey, head of foreign exchange analysis at Monex Europe, said the ECB may hit terminal rates at 3.75% and believes it isn’t in their best interest to officially announce this yet. “Doing so would prompt a premature loosening in financial conditions that could ultimately lead to further rate hikes being required.”
If US growth data and Wednesday’s Federal Reserve decision indicate a further rate hike is likely in the US, the euro-dollar rate could head back below 1.10, Harvey said. The rate stood at 1.11 on Tuesday morning.
AllianzGI says more hikes possible
Franck Dixmier, Global CIO Fixed Income at AllianzGI, sees a need for the ECB to tighten further, pointing to a mix of fiscal and monetary policy and the power of government stimulus as factors.
“More hikes are to be expected, which the markets are not anticipating sufficiently,” said Dixmier in a note to investors. The situation in the euro zone is less clear-cut than it is in the US, he said, noting that while headline inflation continues to decelerate in the eurozone at +5.5% year-on-year in June compared with +6.1% in May, core inflation is holding up well and clinging to high levels, at +5.5% year-on-year in June compared with +5.3% in May.
“The ECB cannot compromise and must continue to tighten financial conditions,” Dixmier said. “Its credibility is at stake, while inflation expectations remain well anchored. In addition, the central bank has retained some room for manoeuvre, since the 400bp increase in key rates since July 2022 has not so far created any risk to financial stability, and governments do not have any refinancing problems.”
Allianz remains cautious on euro rates because markets lack a “margin of safety” as they project only a single additional hike between September and the end of 2023 to reach a terminal deposit rate of 4%. “The risk of the ECB continuing to tighten monetary policy beyond 4% is not being taken into account,” Dixmier said.
Berenberg sees 60% probability
With the “rate plateau” approaching, German private bank Berenberg expects a more balanced communication when ECB president Christine Lagarde speaks on Thursday. “We see a 60% probability that the ECB will hike again by a final 25 bp on 14 September,” economist Salomon Fiedler said in a note to investors. “However, softer data such as the drop in the Eurozone composite PMI indicate that the central bank will stay put in September already.
Berenberg noted “a lingering chance” that the ECB, instead of September, may raise rates a bit further in October or December after a pause. The German bank dismissed as unlikely projections from the Overnight Index Swaps (OIS) market that suggest the ECB will start cutting rates again in the first half of 2024, given that inflation is expected to remain above 2% over the medium term.
Even if the Fed and the Bank of England start reducing their interest rates in 2024, Berenberg expects the ECB to keep its rates high for a long time.
Rate outlook - close to the peak
Monday’s release of the Eurozone Purchasing Managers Index for July pointed to contracting economic activity at the start of the third quarter. In July the PMI dropped to 48.9 from 49.9 in June. A number below 50 points to a shrinking economy.
Tuesday’s Bank Lending Survey by the ECB said lending slowed at the end of the second quarter. Banks continue to tighten credit standards, pushing down business and mortgage lending. Net demand for business loans was close to historical lows. Rejection rates for housing loans increased during the second quarter.
The survey highlighted that the monetary tightening since summer 2022 continues to be transmitted forcefully to the real economy, said Simon Harvey at Monex Europe. The report “adds to a growing case for the ECB to end its tightening cycle with a deposit rate of 3.75%. In our eyes, there is only one compelling risk that the central bank hikes once more in September and that is the labour market, where the unemployment rate sits at a record low and unit labour costs have risen.”
Related articles on Investment Officer Luxembourg:
- ECB shows no signs of considering a rate pause
- Chart of the Week: An exodus of doves?
- ECB seen hiking 25 bp as policy impact becomes clear