ECB & BoE rates nearing a peak

ECB View: March expected to be the final hike

The ECB hiked its key policy rates by 50bp at its meeting today, which was in line with the expectations. It kept the phrase in the statement that the Governing Council ‘will stay the course in raising interest rates significantly at a steady pace’, but also signalled that it ‘intends to raise interest rates by another 50bp at its March meeting’. Subsequently, ‘future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach’. During the press conference after the meeting, ECB president Lagarde signalled that with the 50bp hike in February and the planned 50bp hike in March, the ECB had met its guidance from December, when it said that rates still needed to be raised significantly at a steady pace. Also, she mentioned that the central bank now sees the risks to inflation as being ‘more balanced’, whereas the December statement still mentioned that ‘the risks to the inflation outlook were primarily on the upside’.

Our ECB base case

We continue to expect the deposit rate to peak at 3.00%, which implies that the 50bp rate hike in March would be the final one and that rates will be kept on hold for a while after that. We think that over the coming months it should become clear that eurozone GDP will contract moderately during most of 2023, as the impact of monetary tightening comes through. This also means that labour market conditions are set to deteriorate, during the course of the year, which should help reduce wage growth in the second half of the year and in 2024. Also, inflation could come down much more quickly than the ECB projected in its December forecasts. Meanwhile, we have pencilled in a pivot by year end, with rate cuts beginning in the fourth quarter. The risks to our view are skewed toward a more aggressive path on the 3-month horizon, although it seems likely that the pace of the hikes will be reduced to 25bp in case the central bank decided that rates should move further into restrictive territory.

BoE View: Rates nearing a peak, if not already at a peak

The MPC raised its policy rate by 50bp to 4.00%, which was in line with consensus but above our forecast for a 25bp hike. The vote was split 7-2, with the two members voting against preferring no change at all in Bank Rate. The MPC raised its growth forecasts, and lowered its inflation and unemployment forecasts, bringing its view closer to our own that the unfolding recession will now be a relatively shallow one. Assuming Bank Rate stays well in restrictive territory over the coming years (as markets currently price), the Bank still expects inflation to significantly undershoot the 2% inflation target in 2-3 years, but the statement noted that the risks to this forecast were ‘significantly’ to the upside. This appears to be largely linked to the tightness in the labour market and the upside risks to wage growth. Still, the MPC also left the door open to there being no further rate hikes, with further tightening conditional upon ‘evidence of more persistent [wage and inflationary] pressures’ than the Committee currently has in its base case. The MPC also removed the previous, hawkish reference that it would respond ‘forcefully’ if needed to dampen inflationary pressures, suggesting that it is increasingly confident it has tightened policy sufficiently to ensure inflation falls back to target.

We now expect one more 25bp hike, with the risk skewed to no further hikes

Following today’s decision, we add a further 25bp rate rise to our profile, with Bank Rate therefore now expected to peak at 4.25% (previously 4.00%). However, the BoE is now moving into data dependent mode, in our view, and so we see a significant risk that the last 25bp hike does not materialise. We continue to expect the MPC to start lowering rates from Q4 this year, given that inflation is expected to be significantly lower by year end, and the unemployment rising, thereby reducing risks to the medium term inflation outlook stemming from labour market tightness.