ECB opens door to September pause
The ECB raised its policy rates by 25bp as was widely expected, which took the deposit facility rate to 3.75%. In the press conference, President Christine Lagarde sounded much less sure about further rate hikes, saying that both a pause and an additional hike were possibilities in September. Our base line is that July marked the peak in policy rates and that we will see a pivot around the turn of the year as we expect growth and inflation to come in significantly lower than the ECB projects. Meanwhile, the central bank cut the remuneration rate on minimum reserves to 0%, down from the deposit facility rate it pays currently, which we read as a measure to reduce the net interest income drag on the Eurosystem’s P&L. However, the positive P&L impact for the Eurosystem and – on the flipside - the negative impact on the commercial banking system’s net interest income will not be a game changer.
September pause depends on lower underlying inflation
While in previous press conferences, Ms Lagarde has tended to signal a rate hike at the subsequent meeting quite strongly, this time was different. The ECB President said the Governing Council had ‘an open mind’ saying ‘we might hike, and we might hold’. She even pre-emptively steered expectations for an hold decision in September by stressing that it would not ‘necessarily’ preclude subsequent rate hikes. The decision at the next monetary policy meeting would ‘follow a data-dependent approach’. Emphasis was placed on upcoming inflation reports and progress in underlying inflation. Indeed, currently, the ECB remains unconvinced about progress in underlying inflation, saying only that ‘some measures’ show signs of easing, but that it ‘remains high overall’.
Demand hit from rate hikes now visible
The Governing Council sounded more convinced that its monetary policy is now weighing on the economy. In the statement it noted that ‘past rate increases continue to be transmitted forcefully: financing conditions have tightened again and are increasingly dampening demand, which is an important factor in bringing inflation back to target’. In the June statement, the impact on demand from tighter financial conditions was still only a future expectation. Indeed, the ECB also admitted that ‘the near-term economic outlook for the euro area has deteriorated, owing largely to weaker domestic demand’ and that ‘the economy is expected to remain weak in the short run’. However, it seems to be sticking to its optimistic view beyond that, saying ‘over time, falling inflation, rising incomes and improving supply conditions should support the recovery’.
Rate cut on minimum reserves
The ECB decided to reduce the remuneration of minimum reserves to 0% as of 20 September, whereas it currently pays interest at the deposit facility rate currently. The ECB explained the decision as helping to ‘preserve the effectiveness of monetary policy by maintaining the current degree of control over the monetary policy stance’. However, we read it as a measure to reduce the amount it pays on reserves to reduce the drag of negative net interest income (as the deposit facility rate exceeds the yield on its securities portfolio) on its profits. Indeed, the IMF estimates that the Eurosystem will incur losses of EUR 55bn in 2023-2024. While it has enough provisions to absorb the losses, this is not the case for the Bundesbank where losses could exceed both provisions and capital by 2025. In any case, while the measure will help, it will not be a game changer in this respect. The amount in the current account covering the minimum reserve system currently stands at EUR 157 bn, while excess reserves in the deposit facility stands at EUR 3634 bn. On the flip side, the measure will reduce the interest income of commercial banks, but again the impact will not be great, given that the sector’s net interest income came in at EUR 240bn last year.