ECB to hike this week and signal more on the cards

The communication at the April meeting as well as in speeches since suggest a rate hike at the upcoming meeting is highly likely. In May, the Council noted that upside risks to inflation had ‘intensified’ and that developments were already moving away from its baseline in March. Although its central scenario in March had inflation more or less back to target at the end of 2028, this already included the dampening impact of between two and three rate hikes.

President Lagarde was quite open in signalling that the June meeting would be the moment to move. She noted that it would be the ‘right time to assess’ developments, given the central bank would have more data, new projections as well a better understanding of where the Iran conflict was heading. Financial markets are also fully pricing in a rate hike at this meeting (more than 97%), and it is also the overwhelming consensus of economists. So the focus of this meeting is on the forecasts and communication to get more guidance on what happens next.

We think the Governing Council will signal that it will likely have to raise interest rates further, and in our base case we expect another 25bp hike at the next meeting in July. It will likely significantly raise its near-term headline inflation projections, while we would also expect a higher core inflation over the whole horizon. Inflation expectations have risen, supply-side bottlenecks are building and we would expect to see some spill-overs into non-energy prices. At the same time, the risks of a more significant energy price shock remain, particularly in light of the latest re-escalation between Israel and Iran, and given that the Strait of Hormuz remains closed with OECD oil inventories declining sharply. Against this background, the ECB will likely judge that the risks to inflation over the medium term remain tilted to the upside even after a June rate hike.

The downside risks to the economic growth outlook will unlikely dissuade the ECB, as long as the outlook remains for moderate economic growth. Although the eurozone economy contracted in Q1 according to Friday’s second estimate, this reflected a collapse in Ireland’s GDP (-12% compared to -2% in the initial estimate). Due to its volatile and non-fundamental nature, the ECB tends to look through swings in Ireland. Stripping out Ireland, the eurozone economy grew at a respectable 0.3%, an upward revision from the first estimate. Furthermore, model estimates of the impact of oil prices on GDP suggest that moderate economic growth should continue this year given current prices. Overall, the Governing Council is likely to be more worried about inflation than growth. (Nick Kounis & Bill Diviney)