Hike Then?: Five Questions for the ECB

LONDON (Reuters) – The European Central Bank appears intent on pulling the trigger for a rate hike on Thursday, but what it will do after July is far from certain, and financial markets are craving some guidance.

Eurozone interest rates rose 400 basis points in the past year to 3.5%, their highest level in 22 years, and are now nearing a peak as general inflation slows and the economy weakens.

“The difference (from previous meetings) is that they have so far provided very precise guidance at least as far as the next meeting is concerned,” said Silvia Ardagna, head of European economics research at Barclays. “And we expect that to become more seamless.”

Here are five key questions for the markets.

1/ How much will the ECB raise interest rates?

A quarter percentage point increase to 3.75% is priced in by markets and expected by economists.

Core inflation is slowing but still high enough to warrant a modest increase. The European Central Bank announced the move in July.

“The ECB will raise again and anything else will be a big surprise,” said Peter Shavrik, global macro analyst at RBC Capital Markets.

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2/ What signals is the ECB likely to send about future policy?

Market consensus for a further rally after July is no longer strong after some ECB hawks suggested that the September rally is uncertain, so the ECB may turn more cautious in its signals, while emphasizing that it will be data dependent.

β€œ(Christine) ECB President will stress uncertainty and conditionality (when and if she mentions further tightening),” said Massimiliano Maccia, chief fixed income specialist at Allianz Global Investors.

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Some analysts expect the ECB to pause in September, when updated staff forecasts give it an opportunity to signal that inflation has reached its 2% target.

They added that they would not be surprised if the ECB paused and later rose if necessary, as the US Federal Reserve did. Money market rates picked up again after July, suggesting rates will peak at around 4%.

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3/ When does the ECB expect core inflation to drop?

While headline inflation fell for the third month in a row in June, so-called core prices, such as those for services, rose stubbornly and are not expected to ease soon.

Core inflation, seen as a better measure of the underlying trend, only fell to 6.8% from 6.9% – far from the sustained decline that rate setters want to see.

ECB President Lagarde will likely be pressed on this question but may not give too much away before the new September economic forecasts.

“Core inflation will be very, very slow to come down, so that’s a concern for the ECB,” said Reinhard Klose, chief European economist at UBS, referring to the tight labor market and wage pressures.

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4/ What does a weak economy mean for politics?

Well, the interest rate setters reiterated that the main focus remains inflation, even if monetary tightening hurts the economy.

“I think (weakness in the economy) will have little impact on monetary policy,” said Robin Segura Kaiwela, European economist at Bank of America. “What matters at the September meeting will be core inflation.”

However, slower growth can lead to stiffening of doves’ hands. Business activity in the eurozone stalled in June as the industrial recession deepened and the once resilient service sector barely grew.

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Bank of America believes that the European Central Bank’s forecasts are very optimistic. Barclays expects a recession for several quarters starting in the second half of 2023.

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5/ What is the impact of policy tightening on financing terms?

Bank lending data indicates that the sharpest rise in borrowing costs in the ECB’s history is beginning to take its toll on credit conditions and the latest figures released on July 25th are in focus.

Chief Economist of the European Central Bank Philip Lane He says The volume of loans has weakened sharply, which could lead to a “significant” drop in economic output.

This dovish message, if bolstered by the latest bank lending data, could fuel speculation that interest rates are close to peaking.

β€œThe impact of tightening financing conditions will peak at the end of this year and the first half of 2024. So there is still a lot of impact,” said Segura Kaiwela of Bank of America.

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Reporting by Naomi Rovnik and Dara Ranasinghe in London and Stefano Ribaudo in Milan, Illustrations by Vincent Flasor, Sumanta Sen, Bassit Konkonakornakul, Kripa Jayaram, Editing by Catherine Evans

Our standards: Thomson Reuters Trust Principles.

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