ECB still anticipates further hikes
The ECB raised its three key policy rates by 25bp, leaving the deposit rate at 3.25%. The move represented a slowdown in the pace of rate hikes. The Governing Council also signalled that it expected to discontinue the reinvestments under the APP as of July 2023. This will reduce the APP portfolio by about EUR 25bn per month, which given its size represents a very slow rundown. Both decisions were in line with our expectations.
For now, the ECB’s main consideration is elevated levels of inflation. It noted that ‘the inflation outlook continues to be too high for too long’ and that ‘underlying price pressures remain strong’. Overall, the ‘incoming information broadly supports the assessment of the medium-term inflation outlook …(as)… at its previous meeting’ which we judge was consistent with a terminal rate of around 3.75%.
The Governing Council increasingly sees that past policy tightening is feeding through in a major way. It now also emphasised that ‘past rate increases are being transmitted forcefully to euro area financing and monetary conditions’. However, it currently judges that these developments are not large enough to dampen inflation sufficiently without further rate hikes. Indeed, in the press conference, President Christine Lagarde made it clear that the central bank was not announcing a ‘pause’ and that it has ‘more ground to cover’.
The ECB did refrain once again from explicit forward guidance on the extent of future moves, stressing that it remains data dependent. The statement noted that ‘future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary’ and that it ‘will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction’.
Our base case is for two further steps of 25bp in each of the June and July meetings. However, the sharp tightening of bank lending conditions and collapsing loan demand suggest the risks are titled towards a somewhat earlier end of rate hikes. In any case, we think that as the tightening feeds through, the economy is likely to prove much weaker than the ECB currently expects in the second half of the year. As such, we expect an easing cycle to start from around the turn of the year. (Nick Kounis & Aline Schuiling)