MNI SOURCES: ECB Seen Likely Hiking Twice More

European Central Bank officials are converging on two more 25bp hikes, with a July increase probably following one certain for June, as updated macroeconomic projections are likely to show inflation weakening to the 2% level by 2025 based on current markets curves implying a peak deposit rate of about 3.75%, eurosystem sources told MNI.

Next week’s decision should be straightforward, containing not just a hike to 3.5% but also confirmation of an end to reinvestments under the ECB’s Asset Purchase Programme. The statement is likely to repeat that rates should remain at restrictive levels for however long is necessary, while retaining the commitment to data-dependant meeting-by-meeting decisions, and would certainly avoid any phrasing which might be interpreted as pointing to cuts any time soon.

“The projections will heavily imply there will be another hike to come, which could be July or September, but I'd favour July unless there is a nasty surprise in the lending survey data,” said an official at one national central bank.

Headline inflation should be projected on target by the end of the forecast period, he said.

“On core, 2023 could be higher, closer to 5% than the 4.6% in the March outlook, but again back at 2% by end 2025 -- but all at target based on rate curve peak around 3.75%.”

ECONOMY SLOWING

Still, with the eurozone already in technical recession, doves including Bank of France Governor Francois Villeroy de Galhau, could argue for a pause in July if June’s harmonised inflation comes in as weakly as in May, when, preliminary data shows, the headline annual figure slowed more than expected to 6.1%. On the other extreme, hawks could point to stubborn core inflation, which is likely to be projected at 5% for this year, and might argue for an increase in September to take the deposit rate to 4%. (See MNI SOURCES: Most At ECB See 4% Rate As Only Outside Chance)

An official at another central bank said at least two more hikes were likely.

“For me, two increases in June and July are almost certain, but from September it is 51-49 in favor of pausing,” he said.

It was important, several sources emphasised, that language used by President Christine Lagarde in phrases such as “there is more ground to cover” against inflation, could imply tightening via not only rate hikes but also via reducing the ECB’s balance sheet or holding rates at peak for an extended period. (See MNI POLICY: ECB's Reinvestment Wind-Down Equates To 25bp Hike)

“I would advocate keeping the restrictive level, no matter the level, but keep the restrictive level longer. Certainly more time than the markets are betting,” one source said. “Whether the euro area terminal rate is 3.75 or 4 is irrelevant. But if it’s 3.75 keep it for a year or two years and if it’s 4 keep it for a little less.”

FISCAL RISK

Risks to the inflation upside are easing, the official said, pointing to the slowing Chinese economy and deflating fears of another inflationary winter spike in gas prices. Fiscal policy around the eurozone, however, remains too expansionary, he cautioned.

“We face the question of whether fiscal policy will be contractionary in 2024, as will be factored into the forecasts, or not,” the source said, adding that it would have been better if governments had been quicker to wind up fiscal support measures enacted in response to the Ukraine war.

An ECB spokesperson declined to comment.