Already at the Jackson Hole economic symposium, the Federal Reserve (Fed) and other major central banks such as the ECB highlighted what is their main mandate, to achieve low and stable inflation of around 2%, despite rising unemployment and the risk of recession.
After that meeting, and ahead of the imminent meeting of the European monetary authority, we wondered whether it would continue with a controlled interest rate hike or show signs of tightening. However, a large part of the forecasts coincided in the same prediction, a rise of 75 basis points like the one finally decided by the entity presided over by Christine Lagarde and which takes interest rates to their highest point in the last decade. Specifically, since 2011.
With this decision by the ECB’s Governing Council, the interest rate for its refinancing operations will stand at 1.25%; the deposit rate will reach 0.75% and the lending rate, 1.50%. Moreover, the monetary authority has explained that it has taken this decision today and that it plans to continue raising rates after this large increase – the highest so far – because “inflation remains too high and is likely to remain above target for an extended period”.
Here are the conclusions of leading industry professionals and analysts:
Martin Moryson, Chief Economist Europe at DWS
It is a historic decision. Half of the member countries are now suffering from double-digit inflation. The ECB could no longer ignore all this and acted more boldly than most observers would have given it credit for recently. Finally, the ECB seems seriously willing to fight inflation.
And according to its own projections, inflation will remain significantly too high until the end of the forecast period. The ECB assumes inflation rates of 8.1 percent in 2022, 5.5 percent in the following year and still too high 2.3 percent in 2024. These forecasts seem very realistic. On the growth side, the forecasts are also largely in line with ours. They assume weakening growth over the winter, but – in the base case – not a severe slump.
The decision to raise interest rates by 75 basis points was unanimous. Perhaps intended as a concession to the doves in the Governing Council, there is no longer any direct forward guidance; instead, the ECB emphasizes the data dependency of its future decisions, which is now called the “meeting-by-meeting approach”. This could yet fall on the toes of the doves in the Governing Council.
Inflation rates will leave the ECB no choice but to continue to raise interest rates sharply in October and December, even if the euro area is already looking towards a softening by then due to the consequences of the looming energy crisis. One should not even rule out interest rate hikes of 100 basis points if inflation rates continue to rise and it becomes clear that the economy is coping better with the energy shortage than many expect.
Silvia Dall’Angelo, senior economist at Federated Hermes Limited
The ECB clearly remains laser-focused on bringing down inflation, which is now projected to remain above target until 2024. Accordingly, the ECB’s forward guidance remained hawkish. The ECB reiterated its intention to raise rates further at its next few meetings, although a meeting-by-meeting, data-dependent approach gives the ECB flexibility to adapt its policy course as needed.
Updated forecasts showed significant downward revisions to growth and a large upward revision to inflation throughout the forecasting horizon. Expectations that inflation will come down to 2.3% in 2024 – the end of the ECB’s forecasting horizon – together with the fact that the ECB staff does not expect a recession later this year, likely emboldened the ECB in stepping up its fight against elevated inflation. This aggressive move was also likely motivated by recent negative news concerning consumers’ medium-term inflation expectations and a further weakening in the euro, which is now approaching parity with the dollar.
However, the ECB’s short-term growth forecasts look far too optimistic. In their baseline scenario, the ECB merely foresees a stagnating economy at the turn of the year, rather than an outright recession. That is likely to prove too optimistic, considering the sharp escalation of the European energy crisis following the recent stoppage of gas provision from Russia. Overall, it looks like the ECB is exploiting a narrow opportunity window to raise rates aggressively with a view to stemming second round effects and the risks of inflation becoming ingrained. As indications of the damage to the economy become more apparent towards the end of the year, the ECB will likely pause its tightening process.
Anna Stupnytska, Global Macro Economist at Fidelity International
The European Central Bank (ECB) hiked interest rates by 75bp at its September meeting, in line with market pricing which indicated a 75bp hike was slightly more likely than 50bp. As the global energy crisis unfolds with Europe bearing the brunt, the ECB took the opportunity to frontload policy tightening before economic damage from the energy shock becomes too large. Squeezing in a ‘jumbo’ hike at today’s meeting was particularly important for the ECB’s credibility in light of increasing downward pressure on the euro and upward pressure on bond yields in recent days.
For now, the ECB hawks rule as addressing high inflation is the key priority, but we believe the window for further hikes is closing fast as the reality of gas disruptions takes its toll. We continue to expect the ECB to abandon its hiking cycle later in the year. We note, however, that macro developments in Europe remain uncertain and will crucially depend on the size and composition of fiscal responses which will in turn shape the ECB path from here.
Martin Wolburg, Senior Economist at Generali Investments
Sky-rocketing inflation pushed the ECB into accelerated frontloading. It again surprised on the upside by embarking on 75 bps rate increase. During the press conference President Lagarde maintained a hawkish tone leaving no doubt that further rate hikes are ahead.
While emphasizing data-dependency it became very clear the focus will remain on bringing inflation down over the medium term and to tame inflation expectations.
Samy Chaar, Chief Economist at Lombard Odier
The European Central Bank raised rates by 75bps on 8 September, following the Federal Reserve in implementing aggressive and frontloaded monetary tightening. The bank markedly revised growth estimates down, and those of inflation up, but stopped short of forecasting a 2023 recession as its base scenario. No further detail was given on the Transmission Protection Instrument to prevent spread widening, and no amendments were made to the policy on reinvesting assets under the APP and PEPP.
Overall, the tone was hawkish on rates and inflation, despite growing concerns on growth. That said, the bank did not deliver any major hawkish surprise – for example, by committing to send rates into restrictive territory, or becoming more hawkish on other policy instruments besides rates.
The 75bps decision was unanimous, and the bank forecast further rate rises ahead, dependent meeting by meeting on the path of economic data. President Christine Lagarde refrained from ruling out future 75bp rate rises and said that rates were far away from the level necessary to bring inflation back down to its 2% target. Its 2024 projections still see inflation at 2.3%.
This record-high inflation – which is broadening across more sectors of the economy, including services – and a worsening supply shock, is forcing the bank’s hand. Its decision seeks to guard against a persistent upward shift in consumers’ inflation expectations, amid a historic low unemployment rate and tight labour market. Meanwhile the euro is hovering near parity with the dollar, having fallen ~12% this year, making imports – including energy and food– more expensive, and worsening price pressures.
We thus believe that given stagnating and potentially negative quarters of growth ahead, rates will not ultimately rise as high as the market currently expects. We see them peaking around 1.5%, below the close to 2.5% terminal rate implied by eurodollar futures. Hiking above 2% would take rates into territory that actively restricts growth – which would be much more problematic for the economic outlook, and something we believe policymakers will be keen to avoid.
Adrian Daniel, Portfolio Manager of the MainFirst Absolute Return Multi Asset
While the press conference was still ongoing, the markets had already expressed their lack of confidence in fighting inflation with weaker equity prices, a weaker euro and rising yields on European government bonds.
In response, the yield on 10-year Italian government bonds is again trending towards 4%, the level at which the emergency meeting was called to address the fragmentation of the eurozone. Moreover, with its forecast of an estimated 0.9% growth in the Eurozone in 2023, the ECB has drawn attention quite obviously to a risk of stagflation. Thus, the overall situation from a capital market perspective seems to remain difficult for the time being.
Charles Diebel, head of Fixed Income, Mediolanum International Funds
The ECB opted to front load their on going rate hike cycle by raising rates by 75bp although this was largely discounted or priced by the markets. The message is clear that they expect to hikes rates further at coming meeting but there is not precommitment to magnitude and will be decided on a meeting by meeting basis. As such they will hike at the next meeting but it may well be a smaller move than todays 75bp.
It is noteworthy that Lagarde highlights that some of the downside risks to the their macro projections have already been seen and thereby growth will be weaker into 2023. But their focus remains on getting inflation down to target over the medium term and thereby they will act further. That said, she commented that bond markets had done a reasonably good job of discounting where they thought they would move to and in turn that suggests this ‘front loading’ is not going to become the norm. But the clear message is that they are not finished.
Wolfgang Bauer, Fund Manager at M&G’s Public Fixed Income Team
With its credibility as the guardian of price stability in Europe on the line, the ECB opted today for the biggest rate hike in its history. Whether front-loading the normalisation process by today’s 0.75% step will have a tangible effect on inflation over the coming months is doubtful, though.
Increasing energy and other commodity prices are creeping into core inflation as higher input prices force businesses to pass on the pain – at least in part – to their customers. This cost-push inflation, to a large degree caused by supply shocks, is very hard to fight with monetary policy tools. To put it bluntly, even the most ambitious interest rate hike by the ECB won’t reopen Nord Stream 1. Arguably, an energy price cap, as it is currently debated in the UK, would be the more effective policy tool under these very particular circumstances.
Sebastien Galy, Senior Macro Strategist at Nordea AM
The problem is not yet whether we’ll see a wage inflation spiral, but if risk will rise compounded by a weak Euro and excessive global demand. European growth could fall as low as 0.9% next year which means the problem of inflation is largely imported from abroad.
What is interesting is that the ECB is starting to focus on the Euro as a source of imported inflation—it has previously focused implicitly on a competitive devaluation. The challenge for the ECB is to support the EUR and, if doesn’t budge to over time, to focus on moving it higher as this will reduce the cost of oil and natural gas. This is a very hard thing to do as rate differentials are too narrow to convince a market bulled up on long dollar trades. The ECB needs to convince the market that it wants a strong Euro without delivering too many rate hikes. Given that the euro’s level is inherently unstable due to large dollar long positions, we could over a period of months see a sharp rise in volatility though range trading is more likely in the next few weeks.
Jan Felix Gloeckner, Senior Investment Specialist at Insight, part of BNY Mellon IM
The European Central Bank left markets with no doubt that they were taking the inflationary threat seriously – hiking rates by 75bps and stating that “several” further rate hikes were to come.
Although higher rates are going to be painful in the short term and will add to the squeeze being inflicted by higher energy prices, anchoring longer-term inflation expectations is critical to prevent a further upward spiral. Today’s decision should hammer home the central bank’s commitment to bringing inflation back down towards target in the years ahead.
Konstantin Veit, Portfolio Manager at PIMCO
The ECB hiked policy rates by 75 basis points, and indicated there is more to come. The ECB didn’t provide much guidance regarding the potential interest rate destination and characterised today’s hike, once again, as front-loading.
We believe the ECB will aim to bring its policy rates into neutral territory reasonably quickly, and expect additional 50 basis point policy rate hikes in October and December as a result. We expect a transition towards moving in 25 basis point increments next year as the hiking cycle pivots from policy normalisation to policy tightening.
The ECB decided to remunerate bank excess reserves at the deposit facility rate and government deposits at the deposit facility rate or Euro short-term rate (whichever is lower) until 30 April 2023. These important “plumbing” decisions should mitigate concerns about collateral scarcity and help the ECB to maintain control of money market rates”.
