MNI ECB Preview - September 2023: A Hawkish Hold

A Hawkish Hold

• Conflicting data, limited insight from policymakers since the last meeting, and the very marginal nature of hiking by 25bp or holding following 425bp in policy hikes this cycle, make the September ECB rate decision a tough call.
• We assume that the ECB will leave policy rates unchanged at this meeting, while maintaining a tightening bias and stressing that rates could head higher at future meeting. However, this is a relatively low conviction call.

As most ECB watchers would agree, the September policy rate decision is a very close call between a 25bp hike and a pause (potentially becoming an outright ‘stop’), and we have little conviction on which side the GC will come down on. The forceful transmission of monetary policy has started to bite with headline inflation folding in half since the October peak, but core inflation has proven difficult to unseat and has held steady in a 5.0-5.7% Y/Y range over the same period, while economic activity has slowed. With inflation still some way from target and underlying price pressures showing no sign of abating just yet, erring on the side of caution would augur further rate hikes until the GC has confidence that price stability will be restored. However, policymakers have frequently argued that policy tightening operates with a lag and it is difficult to judge in real time how much of an impact previous hikes are having and whether the ECB has now done enough. The GC will inevitably balance the evidence coming from economic activity data with observations on price trends, but it is not clear how much weight is given to either development. Policymakers have also not given away any meaningful clues, with even the typically hawkish GC members delivering a more balanced message.

The focus of the GC has also gradually shifted away from how high rates need to go, to how long rates should stay at an elevated level. If the persistence of tighter policy is starting to matter more than the spot level, then the ECB may feel more secure in holding fire on further rates hikes for now. It is also worth stressing monetary policy is unlikely to be perfectly calibrated at any given moment and a mere 25bp hike is not going to substantially move the meter in terms of firing a silver bullet and restoring price stability. The impact of another 25bp hike will be marginal on the ECB’s ability to meet the inflation mandate, but what matters around the ‘hike or pause’ decision is what this signals to the market and how it impacts expectations. Hiking by 25bp and maintaining a tightening bias in the official commentary would keep upward pressure on future market-implied policy rates, ensuring that a sufficiently restrictive monetary policy is being transmitted. Conversely, hitting pause and adopting more neutral language at this stage would ease some of that upside pressure and fuel rate cut expectations further along the curve. As mentioned above, we have very limited conviction for this meeting and so we adopt the middle ground of assuming that the ECB will pause on rates, but will maintain a hawkish bias and stress that policy rates could still head higher at future meetings.

For the full publication please see

ECB Preview September 2023 .pdf