Christine Lagarde, President of the European Central Bank (ECB), announced a new rate decision Thursday following new inflation data.
Caisa Rasmussen | Afp | Getty Images
FRANKFURT — The European Central Bank is set to increase its benchmark policy rate by another 25 basis points this week, insisting that all future rate decisions will be strictly data dependent as uncertainty weighs over the inflation and growth outlook.
“Weaker economic data, the significant easing on the energy markets and the recent surprisingly sharp drop in inflation argue for an early end to the interest rate cycle,” said Fritzi Köhler-Geib, a chief economist with German bank KfW, in a research note to clients.
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“On the other hand, growing wage pressure and falling but still high inflation expectations call for caution.”
Recent inflation data shows that price dynamics are abating but consumer price rises are still far too high. At 6.1% year-on-year for the headline rate, and 5.3% for the core rate, inflation remains too high for comfort in Frankfurt with wage pressures still building. Having all that in mind, the new staff projections from the ECB, due Thursday alongside its rate decision, will be key.
“The risks [for the terminal benchmark rate] are tilted to the upside of 3.75%,” said Mark Wall, an ECB watcher at Deutsche Bank, in a research note. The bank’s benchmark rate is currently at 3.25%.
“Inflation was below consensus in May but underlying inflation is still high and we expect upward momentum from tourism-related pricing in the summer,” he said.
“The ECB may have to wait until September and possibly later before it has robust evidence that underlying inflation is slowing enough to skip or pause the hiking cycle.”
Quantitative tightening (essentially cooling down bond purchases that are designed to stimulate the economy) or the acceleration of a shrinking of the ECB’s overall balance sheet seem will likely be left out of the discussions between policymakers this week. Especially after the announcement in May that it will stop reinvestments under its Asset Purchase Program from July 1. APP is a bond-buying stimulus package which started in mid-2014 to deal with persistently low inflation levels. It was frozen between January and October 2019 and then lasted until July 2022 — but continued to reinvest payments from the assets that had matured.
The direction of the economy might get more attention though after the euro area dipped into a technical recession in the second quarter of this year.
The growth picture has a lot of uncertainties attached. While sentiment indicators have actually recovered a lot over the last six months, hard data has not.
“The lack of any clear sign of acceleration of the euro area economy could be explained by the fact that new clouds are rising at the horizon — just as the old ones have vanished,” said Natixis ECB watcher Dirk Schumacher in a research note.
“While companies report ‘equipment as a limiting factor’ being less of a problem in expanding production, a weakening of demand is increasingly seen as a problem.”
—CNBC’s Silvia Amaro contributed to this article.
