ECB Watch - Rate hike on the cards as risks intensify
The ECB’s communications following the April meeting made it clear that a rate hike is on the cards in June. Inflation risks were judged to have intensified and were on the upside as the developments were moving away from the ECB’s baseline. The March baseline itself was predicated on rate hikes, while oil prices have moved significantly higher since then . We expect a 25bp hike at each of the next two meetings taking the deposit rate to 2.5%
Inflation risks intensify
The ECB Governing Council left its key policy rates on hold in April, but the communication following the meeting suggested clearly that it will likely hike rates in June as long as the situation does not dramatically change. The accompanying statement noted that ‘the upside risks to inflation and the downside risks to growth have intensified’. Indeed, it now saw inflation risks as being to the upside over its entire forecasting horizon, rather than more of a near term phenomenon. This reflects that oil prices are now much higher (see chart on the left) and President Lagarde noted that developments were ‘certainly moving away from’ its baseline. In addition, the ECB added that ‘ the longer the war continues and the longer energy prices remain high, the stronger is the likely impact on broader inflation and the economy’.
While supply shocks that impact both growth and inflation adversely complicate decision making, there is no doubt where the central bank’s priority is. The Governing Council re-asserted it commitment to set ‘monetary policy to ensure that inflation stabilises at the 2% target in the medium term’. Indeed, the ECB President also revealed that the Council debated a rate hike already at this meeting and that she knew where the ECB is ‘headed’ on interest rates directionally. For an institution that has moved away from forward guidance, this is as close to a signal of a coming rate hike as you are going to get.
March projections already consistent with hikes
The ECB’s Staff Macro projections were already consistent with higher rates, so recent developments are just making the case stronger. Although its central scenario had inflation more or less back to target at the end of 2028 (see chart below on the left), this already included the dampening impact of between two and three rate hikes (see chart on the right). This is because the ECB uses market assumptions for many variables in making its projections and therefore took the interest rate implied by markets in the run-up to the meeting. This suggests that those rate hikes would be necessary to get inflation back to target in 2027-2028.
June is the right time to assess
President Lagarde was quite open in signalling that the June meeting would be the moment. She noted that it would be the ‘right time to assess’ developments, given the central bank would have more data, the new projections as well a better understanding of where the conflict was heading. Our base case is that the ECB will raise its deposit rate by 25bp at the June and July Governing Council meetings taking it to 2.5%.