ECB moves closer to rate peak after latest hike
Last Thursday 14/09/2023, the European Central Bank (ECB) implemented a 25-basis point (bps) interest rate hike during its policy meeting, bringing the deposit rate up to 4.00%. It’s worth noting that prior to this meeting, the euro-zone rate market had factored in approximately 16 bps of rate hikes, so this increase was not fully anticipated.
In the accompanying policy statement, the ECB acknowledged a persistent decline in inflation. However, the bank expressed concerns that inflation is “still expected to remain too high for too long.” To address this, they decided to tighten their monetary policy further to support progress toward their target.
In response to the rising energy prices, the ECB’s staff raised their inflation projections for this year and the next by 0.2 percentage points, now standing at 5.6% and 3.2%, respectively. Nevertheless, they displayed more optimism regarding inflation, predicting it would approach the target by 2025, as they lowered the inflation projection by 0.1 percentage point to 2.1%. Core inflation forecasts for 2024 and 2025 were also slightly reduced by 0.1 percentage point to 2.9% and 2.2%, respectively.
The dimmer outlook for both headline and core inflation toward the end of the ECB’s forecast horizon is attributed in part to a weaker growth outlook for the euro-zone. GDP growth projections were significantly revised downward by 0.2 percentage points for 2023, by 0.5 percentage points for 2024, and by 0.1 percentage points for 2025. The ECB attributed this downward revision to tightening financing conditions affecting domestic demand and a deteriorating international trade environment.
During the Q&A session, President Lagarde noted that the impact of tightening monetary policy on the euro-zone economy is occurring more rapidly than in previous cycles.
The most significant change in the ECB’s policy guidance was the statement that “the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” This statement strongly suggests that the ECB is nearing the peak of its rate hike cycle and is leaning towards keeping rates steady for an extended period to help bring inflation back to target. However, President Lagarde mentioned in the press conference that it’s premature to declare rates at their peak, leaving the possibility of further rate hikes open if necessary.
The updated policy statement also reiterated the ECB’s commitment to a “data-dependent” approach in determining the appropriate level and duration of restriction. Given this new guidance and the weaker growth outlook, there is growing confidence that the ECB’s deposit rate may have reached its peak at 4.00%. Nevertheless, history has shown that the ECB can be sensitive to rising energy prices, and with inflation already elevated, they may react cautiously to the risk of energy-induced inflation expectations.
In summary, the decision to raise rates by 25 bps and signal a higher likelihood of reaching a rate plateau appears to represent a compromise between the more hawkish and dovish members of the ECB’s Governing Council.
