28 JUL, 2023
By Constanza Ramos
In line with market expectations, the ECB raised interest rates by 25 basis points (as did the Federal Reserve on Wednesday) at its meeting yesterday to 4.25%. This is the ninth consecutive increase by the European Central Bank in the last twelve months.
The agency expects inflation to continue to fall for the rest of the year, but to remain above target for an extended period of time. Here are the first reactions from investment fund industry professionals.
Here are the first reactions from international asset managers.
The interest rate hike announced yesterday by the ECB has been widely expected since the last Governing Council meeting in June. However, there are signs that the European monetary authority is ready to put an end to its current hiking cycle, the most aggressive in its history. This is revealed by a slight but important change in the wording of the Monetary Policy Communiqué. Rates will no longer be “brought to sufficiently restrictive levels”, but “set at sufficiently restrictive levels”. While the door is open to a pause in September, it is not closed to another hike. The decision will depend on the data.
We expect these to be weak enough to warrant a pause, as underlying inflationary pressures are diminishing and activity continues to weaken as the effect of previous tightening is transmitted to the economy.
However, the decision is clearly marginal, and investors will have to follow the data flow closely if they wish to anticipate the ECB’s next move. The main indicators are the release of the ECB’s projections and the two-month CPI figures.
The ECB also raised rates by 25bps today, in a move that had been clearly indicated by President Lagarde in June. These changes take the deposit, refinancing operations, and marginal lending facility rates to 3.75%, 4.25%, and 4.5% respectively. In the accompanying press release, the ECB also announced that they are setting the remuneration on bank minimum reserve holdings at 0%. Inflation remains well above the central bank’s target, however, recent economic activity data releases, including eurozone PMI data and the German IFO business survey, have been weak and point to a slowdown in real GDP growth for the region as a whole, even contraction some countries, and a deteriorating German manufacturing sector.
While today’s 0.25% rate hike was widely anticipated, recent data skews the balance of risks towards less rather than more tightening beyond the September meeting. This sentiment appears to be shared by the ECB, reflected in small tweaks to its post-meeting statement relative to the one published in June.
PMI survey data surprised to the downside, the ECB Bank Lending Survey reflects the transmission of tighter policy into the real economy, and inflation is slowly but surely moving past its peak.
The ECB today approved a 25 basis point hike, in line with market expectations, following a similar move by the Federal Open Market Committee (FOMC) yesterday.
The tone used was, if anything, a little less hawkish than the market had expected, with inflation clearly expected to continue to decline over the course of this year, even if it remains elevated for now.
The key element was perhaps the focus on the fact that the previous tightening was starting to materially affect the level of activity, highlighting that the tightening was still being transmitted. That said, the focus was once again on data dependence and the need to maintain the tightening stance for long enough to reduce inflation in a meaningful and sustainable way.
Overall, in a similar vein to the Fed, the ECB is willing to do more, but also clearly believes that it is close to, if not already its landing zone. Bond markets should get some support, while the currency should hold up in anticipation of the asymmetric view of current policy.
The European Central Bank has delivered as announced: interest rates will rise by another 25 basis points. But the “hawkish tone” of the last press release has softened. Although the central bank expects the inflation rate to remain too high for too long, financing conditions have tightened and dampened demand. This can be considered a success in reducing inflation. With this, the end of the interest rate hike cycle is within reach. However, as before, the ECB continues to insist on data dependence.
In our view, it now all depends on the central bank’s September economic growth and inflation forecasts as to how monetary policy should proceed. Although sentiment indicators are weakening significantly, inflation has not yet been beaten, especially as no relief is coming from wages and the labor market. We, therefore, continue to expect the policy rate to be raised to 4% in September.
Yesterday’s meeting reiterates our view that, while the ECB could continue to raise interest rates, we believe it is approaching cruising altitude. Attention is gradually shifting from the precise level of final interest rates to the likely duration of peak rates.
In our view, risks remain skewed towards later policy rate cuts compared to market expectations. We believe that for inflation to return to full normalization towards the ECB’s 2% target, further cooling of the economy and some labor market weakness are likely to be necessary.
We expect the ECB to make an early reduction in PEPP reinvestments, possibly later this year. We do not expect it to categorically rule out selling its bond holdings outright but will continue to focus on a gradual and orderly passive reduction of reinvestments.