25 JUL, 2023
By RankiaPro Europe
The ECB meeting will take place on Thursday 27 July. At this meeting, the market expects Christine Lagarde, ECB president, to raise interest rates again by 25 basis points. In fact, this is something she already stated at her last meeting in June.
Fund managers are focusing on the press conference afterward, so we will have to stay tuned and see if the European Central Bank gives any clues as to its next moves. In the meantime, we leave you with the fund managers’ outlook for Thursday’s meeting.
On the rate front, there is little doubt about the 25 basis point hike at the July meeting, which would leave the euro zone’s deposit facility at 3.75%. More important will be the forward guidance on the next actions, as after the restrictive messages at the last monetary policy meeting in June and at the Sintra forum, an additional hike in September was taken for granted, but since then we have had relevant events that have generated some doubts about the action to be taken at that meeting.
A labor market that, although tight, is starting to show signs of moderation, but above all price data confirming the disinflation process also in the underlying indicators, have led the market to price in less aggressive rate hikes at the next meetings. This has also been helped by the statements of one of the most hawkish members of the ECB (Knot) in which he left the door open to not raising rates in September.
Therefore, the interesting thing about this meeting will not be the rate move, but the message given at the press conference. We will have to see if Lagarde prepares the market for an additional hike in September (as she did at the last meeting), or if she gives any clues about the terminal rates they have in mind, although this is less likely as it is normal for her to change her message from meeting to meeting depending on the data that is published.
Regarding bond purchase programmes, we do not expect any major news, although ECB members will probably start to discuss how to reduce the balance sheet in a more accelerated manner from late 2023 or early 2024. We believe that, in this case, the most likely scenario would be the gradual reduction of PEPP (pandemic purchase programme) reinvestments, ruling out for the time being the option of selling bonds in the secondary market as the Bank of England is doing.
We do not expect announcements regarding TLTROs, after the strong June window maturity, which so far has been well absorbed by the market.
We believe the European Central Bank (ECB) will hike policy rates by 25 basis points at its July meeting, to 3.75% on the deposit facility. We do not expect the ECB to make any changes to its current bond portfolio reinvestment guidance.
Instead of providing firm guidance beyond July, we expect the Governing Council (GC) to point to the next round of staff macroeconomic projections, allowing for a comprehensive assessment of inflation dynamics in September.
The market anticipates a 25 basis point increase in rates for July, followed by an additional 20 basis points over subsequent meetings, and rate cuts to begin in Q1 2024. While we find the currently priced terminal rate of 3.95% reasonable, we remain doubtful that the ECB will implement rate cuts as early as projected, given the persistent nature of underlying inflation.
The Euro area’s unemployment rate currently stands at a historic low of 6.5%, a full percentage point below pre-pandemic levels, with further declines expected. In addition, the impact of the ECB’s tighter monetary policy on the real economy remains uncertain. To achieve full normalization of inflation towards the ECB’s 2% price stability target, additional economic cooling and some weakness in the labor market are likely necessary.
The ECB already agreed de facto at its last meeting to a rate hike ahead of this July’s meeting. It would therefore be a real surprise if it did not raise official interest rates by 25 basis points next Thursday. In that case, the deposit rate would then have to stand at 3.75%. Ultimately, however, the interest rate outlook is decisive and will be the main topic at the press conference. Here, however, ECB President Christine Lagarde will probably not give a clear answer. The underlying price trend remains worrying. But a preliminary determination on whether another rate hike will be necessary in September will probably be rejected, given the new growth and inflation projections expected by then.
Thus, the ECB remains data-dependent. Inflation rates in July and August, as well as sentiment indicators, are likely to play a key role in the September decision. Recently, even the governor of the Dutch central bank, Klaas Knot – a hawk – called a September rate hike uncertain. This has fuelled speculation, especially in the bond market, that the rate hike cycle could end sooner. However, given that, in our view, neither the labour market nor the underlying price trend will weaken significantly, we continue to expect a further rate hike in September.