Will the ECB raise rates more than markets expect in the face of rising inflation expectations?

More interest rate hikes are on the horizon. This is the outlook that asset management industry professionals foresee for the upcoming ECB meetings. Generally speaking, fund managers expect the institution chaired by Christine Lagarde to raise rates again by 50 basis points - as it did at its last meeting on February 2.

Many voices point to the fact that the European Central Bank could raise interest rates more than the markets expect in the face of rising inflation expectations. Below, you can find out what industry experts think about what they expect to happen at the ECB meeting on Thursday, March 16.

Rubén Segura-Cayuela, Chief European Economist, Bank of America

We believe the ECB is headed for excessive tightening. And the signals we have received this week keep us very concerned about a likely ECB overreaction: the economy has been and remains weak, some budding inflationary pressures are heading in the right direction, and fiscal policy is unlikely to provide additional inflationary impetus (if anything, it could soon take a turn for the worse).

European households are being squeezed at an unprecedented rate, and real consumption growth is turning negative. Consumers are paying much more for the same thing: while nominal retail sales are more than 20% above pre-crisis levels, sales volumes are quite close to pre-pandemic levels. And the picture is similar if we look at private consumption figures from the national accounts. We cannot be optimistic about the outlook for consumption in the future, as even as pressure on real incomes eases, the impact of rising interest rates will be felt.

We expect a 50 bp hike with, at the margin, some guidance of 50 bp in May unless core inflation improves sooner. Forecasts are likely to be hard-line (more short-term) and moderate-line (more long-term). With wide ranges of uncertainty. Internal disagreements may not allow Lagarde to be forceful: given that pricing is already hard-line, we see risks that the market reading will be pessimistic.

Jeremy Cunningham, investment director at Capital Group

The ECB may raise rates more than markets expect as inflation expectations rise. The European Central Bank has announced its intention to continue raising interest rates, citing a "significant upward revision of the inflation outlook", and has also indicated that it will begin to reduce the bonds purchased under its asset purchase program. ECB President Christine Lagarde specified the inflation risks: in the short term, they revolve around energy prices and the trajectory of the Russia-Ukraine conflict, and in the medium term, the main risk is rising inflation expectations. The latest ECB survey data on consumer expectations show a sharp rise in one-year inflation expectations and a further increase in three-year expectations. This could increase wage pressures as workers digest the rise in inflation expectations, and points to the possibility that the ECB may decide to raise rates more than the market expects.

Ulrike Kastens, Economist Europe for DWS

More rate hikes are on the horizon. The European Central Bank is far from reaching its inflation target in the medium term, so, as already anticipated at the February meeting, it is likely to raise policy rates again by 50 basis points at its next meeting on Thursday, March 16, when the deposit rate would stand at 3%.

Comments from numerous ECB members indicate that even this rate hike would not be the end of the road. The core inflation rate, which rose to 5.6% in February, is likely to have alarmed ECB Governing Council members, especially given the prospect of further increases. On the other hand, the labor market remains solid, wages will rise and labor shortages will also continue to lead to upward wage adjustments. However, the first signs of a slowdown are also visible, the economy is slowly losing momentum, and lending, especially in the housing market, is slowing significantly.

Nevertheless, the ECB is likely to continue to view the risks to the medium-term inflation outlook as greater than the negative effects of monetary tightening on the real economy. This should also be reflected in the growth and inflation forecasts. Particular attention is paid to the projection of price increases for 2025, which is currently estimated at 2.3%. We assume that the new projections will also show a further breach of the inflation target. In this regard, the ECB's core message is likely to be that it will remain data-dependent, but will fundamentally stay the course of interest rate hikes. In this scenario, we expect the deposit rate to rise to 4% in the summer of 2023.

François Rimeu, Senior Strategist, La Française AM

Until now, it was widely expected that the ECB would raise its interest rates by 50 basis points (bps) at its next meeting; the question now is if the ongoing collapse of US regional banks could lead them to adopt a less restrictive approach. Updated staff projections are likely to show much lower headline inflation this year, but faster GDP growth and higher core inflation, with minimal adjustment to both over the medium-term horizon.

We expect:

At the time of writing, the market is no longer expecting a 50bps hike coming from the ECB (33bps priced). We think that the ECB will most likely “stick to the plan”, which means higher rates on the very short end of the curve.

Peter Goves, Fixed Income Analyst, MFS Investment Management

The ECB is expected to raise interest rates 50 basis points to 3% this week. At the previous meeting there was already some advance on this, so it will not be a surprise. What will be more important will be the forward-looking speech (i.e. the possibility of further 50 basis point hikes) and the ECB's new macroeconomic projections. Overall, we expect forward commitment to be data-dependent. Although headline inflation is falling, core inflation seems more persistent. Thus, the ECB remains on a clear mission to bring inflation down from the current elevated levels. Uncertainty around the inflation outlook remains elevated, which may have played a part in the market overshooting, along with global factors.