Yesterday, for the first time in more than a year, the ECB left interest rates unchanged, bringing an end to its unprecedented streak of 10 consecutive hikes. The benchmark deposit rate is now 4%, four and a half percentage points higher than it was until July 2022.
The decision was far from being surprising, as you might have seen from my tweets, as inflation in the eurozone has more than halved from its peak and the economy is starting to show some signs of weakness. From my comments on the previous ECB meeting, that you can read here:
“It’s not surprising that Lagarde attempted to downplay the dovish nature of the hike: it would make no sense from a strategic point of view for the ECB to commit to a rate peak, as they need the flexibility to respond if inflation surges again. However, looking at recent economic data coming from the Eurozone, it’s my belief this was indeed a dovish hike.”
The statement didn’t change that much, although there is a clearly more dovish tone in it.
Like its peers, the ECB didn’t exclude the possibility of further hikes should inflation fail to ease quickly enough, but to be fair there’s little doubt that September’s hike was the last one. Indeed, right now the markets are pricing in less than a 10% chance of further hikes by the ECB.
There are a few reasons to believe the peak in ECB rates is in. The first one, is narrative: during the press conference, it was stressed how much its earlier rate rises were already squeezing activity, and it was even said that growth was “likely to remain weak over the remainder of the year” as the impact of higher interest rates was “broadening”.
“The economy is likely to remain weak for the remainder of this year. But as inflation falls further, household real incomes recover and the demand for euro area exports picks up, the economy should strengthen over the coming years.” (from the ECB Press Conference)
The second one is data: just take a look at the PMIs for the major European economies, and you’ll see the picture is far from being optimistic. Unsurprisingly, the expectation for next week’s 3Q GDP figures is to show a contraction in output.
However, this doesn’t necessarily mean that we should expect cuts soon, and Lagarde herself said that discussions on cuts are still totally premature. I expect the ECB to cut no sooner than the second half of 2024, unless some kind of crisis forces them to speed up the process: therefore, in my opinion, any cut priced in for the first semester of next year is to be faded.
In general, if I had to summarize the meeting, I’d say that concerns about growth are prevailing over inflation: they didn’t sound particularly concerned about the upside risk to inflation posed by the tensions in the Middle East via energy prices, while the weak economy was mentioned several times.
Finally, near the end of the press conference, something very important was said. If you recall my meeting preparation tweet, a significant risk was the discussion of balance sheet reduction and reserve remuneration. Indeed, some analysts expected the ECB to reduce the amount of interest it pays to commercial banks on their deposits, and to bring forward the end of reinvestments in its €1.7tn portfolio of pandemic-era bond purchases. However, Lagarde said neither subject had been discussed at this meeting.
Next week, we’ll have the Federal Reserve on November 1st and the Bank of England on November 2nd, and they are both expected to keep the rates unchanged.
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