The European Central Bank hiked rates again this afternoon despite a eurozone slowdown as inflation numbers remained high. It revised its inflation outlook to 5.6% this year and 3.2% in 2024. In its previous forecast in June, it had projected rates of 5.4% and 3% respectively.
Following the announcement, the euro declined as much as 0.7% to its weakest level against the dollar since May. Shares in the Stoxx Europe 600 Index extended gains to 1%.
A majority of economists were predicting a pause in rate increases at the beginning of the week, and euro short-term rate forward (ESTR) was pricing in a 40% probability of a 25 basis point rate hike. Sentiment shifted after Reuters reported that the inflation outlook was about to be revised higher. By Wednesday evening, ESTR implied a 63% probability of a quarter-point hike.
Following Thursday's decisions, the main refinancing rate stands at 4.50%, the marginal lending facility rate at 4.75% and the deposit rate at 4%. Comments by President Christine Lagarde at a press conference in Frankfurt signaled there was dissent among Central Bank governors, though a "solid majority" agreed to raise rates.
"Inflation continues to decline, but is still expected to stay too high for too long," Lagarde told press, citing risks including "potential renewed upward pressures on the cost of energy and food, adverse weather conditions, and the unfolding climate crisis."
No more rate hikes in 2023?
The language in the ECB's statement suggests no further rate hikes are on the table for now: "The Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target."
Patrick Barbe, Head of European Investment Grade Fixed Income at Neuberger Berman, said "the first interest rate cuts are unlikely to be considered until next spring”. Meanwhile, the ECB's lowered inflation outlook for 2025 "should lead to a stabilization of the yield on the 10-year German Bundesanleihe at 2.5%."
“The dilemma is that monetary policy is clearly working for the economy as European growth has broadly stagnated since last autumn”, Deutsche Bank Research commented. The question is whether it’s working fast enough to secure the ECB’s inflation target of 2% going forward? The lag of policy means that further reductions in inflation are still likely to come. The problem for the ECB and markets is that there remains much uncertainty as to how much and how quickly this will happen.”
