Christine Lagarde, the president of the European Central Bank, on Thursday declined to provide forward guidance on the direction of Eurozone interest rates but said that its decision in December will be made based on updated data on inflation and on the actual economic impact of its monetary policy.
Following its monetary policy meeting in Athens, the ECB on Thursday refrained from providing clear forward guidance on the direction of euro interest rates. The central bank announced a pause in its benchmark rates this time, after having raised them in ten back-to-back meetings.
“At this point, after 10 successive hikes, now is not the time for forward guidance,” Lagarde said, adding that the ECB will continue to base its policies on its data. “We shall be data dependent,” she responded when asked for how long the ECB will keep its rates at current levels.
Against this backdrop of ten consecutive rate hikes, investors should brace themselves for potential shifts in economic scenarios. Lagarde’s comments suggest that the ECB could find itself surprised about the strength of the economic impact of higher rates. The economy has yet to bear the full brunt of these higher costs for money and, like the US, could enter a recession. If new data confirms that the brakes have been slammed too much, eurozone interest rates might be eased sooner than expected. Nevertheless, the bank’s emphasis on data, waiting for indicators from areas such as collective bargaining agreements, underlines its determination to make measured policy decisions.
Autopilot activated
Konstantin Veit, portfolio manager at Pimco, commented that the ECB has activated its autopilot regarding interest rates. “While the ECB might increase interest rates further, the focus has shifted towards the likely duration at peak policy rates,” he said in a note to investors.
“The risks remain skewed towards somewhat later rate cuts compared to current market expectations. For inflation to fully normalise back to the 2% target, additional cooling in the economy and some labour market weakness is likely needed.”
Overtightened?
Monex Europe however sees a considerable risk that ECB will start cutting rates again in the first quarter. “Given data has suggested that the ECB has already overtightened policy, there is a considerable risk that rates are cut as soon as Q1,” said Simon Harvey.
The ECB is indeed waiting for new data to emerge. Lagarde reiterated what her chief economist Philip Lane said by stating that the ECB wants to see the outcome on collective bargaining agreements and annual negotiations in 2024.
December will bring “a whole range of new data,” Lagarde said. “We know for a fact that growth has weakened. PMI numbers show growth continues to be weak.”
Financial markets, according to analysts and economists surveyed by Bloomberg, generally expect the benchmark ECB interest rates to stay at the current level of 4 percent until next summer. The ECB applies three criteria when considering the need to change interest rates: the inflation outlook, underlying inflation and the strength of transmission of monetary policy.
Lending data points to further weakness
This week’s ECB data on bank lending made clear that European banks are vigorously passing on the higher central bank rates to their clients. Mortgage rates have risen considerably across Europe and corporate lending is declining, with companies holding back investments.
“What we are seeing is a very strong transmission in the banking sector in particular,” said Lagarde. “Financing of the economy is directly affected, this translates into dampening of demand.”
She said the effectiveness of the monetary policy transmission system is “striking in terms of volumes and demand.”
‘There is more to come’
“We know that there is more to come,” Lagarde said, referring to the impact of higher rates on the economy. “There is more in the pipeline to affect the real economy. It will continue through the end of 2023 and the first quarter of 2024. “It is transmitting to the real economy.”
Asked about December - the ECB’s policy-making council meets on the 14th - Lagarde said she expects that there will be “December we’ll have a whole range of new data,” she said. “We know for a fact that growth has weakened. Pmi numbers growth continues to be weak.”
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