18 SEPT, 2023
By RankiaPro Europe
The ECB meeting will take place on Thursday 14 September. At this meeting, fund management industry professionals did not agree with the decision to be taken by Christine Lagarde, president of the European Central Bank. Some point to a further interest rate hike of 25 basis points, while others believe that such an increase will be postponed.
We will also have to keep an eye on the new economic projections to be presented by the European body at this meeting. As we wait for Thursday to arrive, we leave you with the outlooks of national and international fund managers.
At the last monetary policy meeting of the ECB's Governing Council, it was agreed that policy decisions would continue to be strictly data-dependent. However, it became clear from the minutes of that meeting that there was a growing dispersion of views among its members.
Since then, some Board members have supported a hike. Bank officials have been less explicit, but there is no doubt that some of them are concerned about the apparent emergence of downside risks to the economy. It is therefore unlikely that an agreement will be reached in the Governing Council. Whether the "doves" or the "hawks" will win will depend on their effectiveness in securing the necessary votes to secure their preferred rate decision.
Two factors favour the "hold" faction. First, several of the usual hard-line members will be disenfranchised this week under the Bank's rotating voting system. Second, the only feasible compromise decision for the Bank - to maintain monetary policy along with a hard-line message - avoids an immediate hike. Therefore, we consider it most likely that interest rates will remain unchanged.
However, there is still a good chance of a hike. Such a move could aggravate a recession that, in our view, is already underway. A broad set of indicators suggests that the euro area economy is likely to contract in the third quarter. As the impact of past monetary tightening continues to accumulate, and with no relief in sight, we expect the recession to deepen over the winter.
The outcome of Thursday's ECB Governing Council meeting is unusually uncertain. Dovishness is stronger than ever so far this cycle, with tangible signs that ECB tightening is working its way through the economy and that patience should be warranted, as weakness in the real economy should gradually filter through to the behavior of corporate margins and dampen wage growth. We would expect this to be reflected in the new forecast series, with lower growth weighing on core inflation, which we see at 2.2% in 2025 (from 2.3% in the June series). Still, we would be surprised if the ECB revised its inflation forecasts in 2024 and 2025 sufficiently to be fully consistent with its target, which it said should be reached "in a timely manner.
The main reason why we still consider a 25 basis point hike slightly more likely than maintaining the status quo is of a tactical nature. While leaving policy rates unchanged in September could be presented as a mere "jump", with a continued tightening bias, giving the central bank the possibility to react later if inflationary pressure becomes too tenacious in the coming months, in reality, hawks probably think that not acting this month would seriously undermine the chances of a further hike. Indeed, it is very likely that the data flow from the real economy will deteriorate further, while base effects should push inflation more decisively lower.
It has been close, but, finally, we expect the ECB to raise interest rates one more time next week. A 4% deposit rate, should have been it in this unusual hiking cycle.
Lagarde and her ECB "colleagues" had avoided any commitment prior to this meeting, stressing the data dependence of the upcoming decisions: every piece of information counts. The fundamental question is whether the economic slowdown induced by the rate hikes will be enough to bring inflation back under control. Recent disappointing economic data, both in Europe and globally, are fodder for the dovish movement. However, the latest inflation data, which have tended to surprise on the upside, have become fodder for the hawkish.
The ECB will present its new projections at this meeting. It will have to revise its economic outlook slightly downwards, but its inflation expectations much more upwards. This would be a good opportunity to make the final move and signal to all observers, both markets and consumers, that the ECB is really serious about fighting inflation. We could then sit back and watch inflation rates (slowly) normalize.
Thursday’s ECB policy meeting takes place at a time with strongly diverging signals about the next action. On the one hand measures for inflation expectations stay stubbornly high and negotiated wage growth North of 4% yoy is unprecedented in the single currency’s history. This clearly implies threats to medium term price stability and hence ongoing policy tightening.
On the other hand, the latest activity data, like the PMIs and the downward revision of Q2 growth, surprised on the downside and will prompt the ECB to sharply revise its overall optimistic growth outlook. The ECB’s proprietary measures of underlying inflation have turned and so has PPI inflation. And the past policy action is still passing through the economy and will according to an ECB study continue to do so in 2024 with almost unchanged magnitude according to an ECB study.
While it will be a very close decision we ultimately expect the Governing Council to restrain from another hike at the September meeting. That said, it should come with a hawkish tilt making clear that it is not to be interpreted rather as a pause than the end of the hiking cycle and that further tightening measures could be resumed at any time if needed.
Looking at the latest data, which is pessimistic, we expect the ECB to be more dovish this week. A hike in data that starts to indicate a recession could be somewhat counterproductive. However, if the ECB surprises markets with a hike, markets may start to price in a policy error, loosening financial conditions and pricing in a weaker euro instead. This would make monetary policy less restrictive, increase imported inflation, and would be the opposite of what the ECB wants to achieve.
The view that we are probably entering a recession in the Eurozone, which I have long held, is not yet the consensus economist view but is gaining acceptance among economists and markets following this week's revisions to GDP data.
There is a risk that a hike this week could backfire. By refraining from commenting on the September decision, policymakers encouraged markets to assess monetary policy solely on the basis of the data, and the data point to a pause. If policymakers raise rates despite weak real economy data and an incipient recession, markets may start to price in a policy error.
The fact that the ECB is hiking in what is beginning to look like a recession may push markets to price in further cuts in a year or two. The euro would fall rather than appreciate. This would actually ease financial conditions, implying a less restrictive policy. The euro would probably continue to depreciate, which would increase imported inflation. There is therefore a real risk that a hike next week could backfire.