A fresh flash estimate for inflation in the 20 eurozone countries and the latest ECB bank lending data shows that higher interest rates are slowing down economic growth in Europe, fuelling expectations among fixed income analysts and economists of a smaller rate increase of 25 basis points - following six consecutive hikes of 50 basis points - when the ECB›s monetary policy decides is next step on Thursday.
The EU’s statistics agency Eurostat on Tuesday said that core inflation fell for the first time since June, marginally, to 5.6 per cent in April from 5.7 per cent in March. Overall, non-adjusted inflation came in at 7 per cent for April. Also on Tuesday, the ECB’s bank lending survey showed that higher interest rates now are clearly filtering into the economy, making commercial credit more expensive and slowing growth.
‘Double whammy’
Katharine Neiss, chief European economist at PGIM Fixed Income, said she is firmly in the camp of those expecting a 25 basis point hike. The ECB report on bank lending was “eye catching”, she said, as it showed signs of a “double whammy” hit from tighter monetary policy on credit demand.
“All of that gives more conviction to our 25bp hike call for Thursday’s ECB meeting,” said Neiss. “These data to us suggest the ECB is more likely step down from 50bp to 25bps hikes, not least to reflect a more cautious approach to continued US banking sector fragilities.”
Still supporting the case for a 50 basis point hike on Thursday, Volker Schmidt, senior portfolio manager at Ethenea, said that while eurozone inflation is likely to subside in the coming months, energy prices are not expected to fall permanently. “The economic condition is at least solid, no reason for the ECB to be cautious. And inflation is still far too high, albeit slightly declining.”
‘Uncomfortable decisions’
“The ECB will still have to make some uncomfortable interest rate decisions,” Schmidt said in a note to investors. “In our view, a further interest rate hike of 50 basis points would therefore be the right way to raise the deposit rate from the current 3 per cent to 3.5 per cent for the time being and still to at least 4 per cent by the summer break. As inflation for April 2023 was 7 percent, this will be decisive for the outcome of the interest rate decision.”
At Pimco, portfolio manager Konstantin Veit expects the ECB will hike policy rates by 25 basis points, and, like in March, expects Lagarde et al to refrain from communicating expectations for the future interest rate path.
Terminal rate nearing 4%
At Monex Europe, head of fx analysis Simon Harvey said a 50 basis point hike cannot be fully discounted on the back of recent media comments by hawkish ECB policy makers. These comments might indicate that the ECB terminal rate could be as high as 4 percent, he told clients.
“Although a 50bp hike can’t be fully discounted should the official eurozone core HICP reading on Tuesday show signs of persistence and the ECB’s Bank Lending Survey show negligible fallout from March’s banking crisis, we don’t think any decision to hike rates by 50bps will sway the implicit terminal rate in any case, which we estimate at 3.75 per cent,” Harvey said.
The terminal rate is regarded as the peak rate in the ECB’s current policy cycle, as measured by the deposit rate. Since March, this rate is 3.00 per cent.