ECB facing a conundrum
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Article Type
Insights
Topics
Banks, Macro
Published
June 16, 2023
Read time
3 mins
Author
Luca Ferramosca, CFA
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The ECBs governing council has decided to raise rates by 25bps, lifting the deposit facility rate up to 3.5%.

 

This is the marginal rate that investors watch closely as it has resulted in excess liquidity being injected in the system for years. The hike was largely in line with expectations. Consensus sees a terminal deposit facility rate topping out around 4% at the October meeting with a full cut priced in only after the first quarter of 2024. During the press conference, Lagarde reiterated that the ECB is not done yet with the hiking cycle and there is more ground to cover, despite acknowledging that monetary policy transmission is becoming more effective in influencing financing conditions and the broad economy. Inflation projections were surprisingly revised a notch higher, placing a stronger emphasis on more persistent core inflation (5.1% for this year vs the previous forecast of 4.6%), while keeping a fairly optimistic stance on the GDP growth outlook. Forward guidance on policy rate decisions has been mostly vague thus far, however, Lagarde added that a rate hike in July is very likely. Lastly, the decision to completely cease reinvestments of APP holdings as of 1 July was made official.

 

Navigating strengths and weaknesses

 

Headline inflation pressures in the eurozone have considerably eased and are expected to fall further on the back of lower energy prices and food disinflation. Considering the pass-through effect into core inflation figures acting with a lag, wage negotiations and a still too-expansionary fiscal policy, core inflation could remain stubbornly high for a prolonged period. The wage growth spiral is fueled by relentlessly strong prints in the service side of the survey paired with decreasing overall labor productivity. In fact, recent improvements of the euro area composite PMIs have unveiled a significant divergence between the service and manufacturing side of the economy. Despite fading energy pressures, improving supply chains and high order backlogs, the weakness in the manufacturing sector has raised concerns about the resilience of the eurozone economy. On this latter, industrial production figures have markedly signaled a slowdown in core and semi-core countries, thus paving the ground for conceivably quicker policy normalization.

 

Thursdays policy decision and statement reinforce a hawkish trajectory ahead. Yet, it leaves the ECB in a conundrum of whether to forcefully bring interest rates further into restrictive territory or gradually scale down the pace of hikes amid tighter lending conditions and a potential slowdown in economic growth resulting from softer credit demand.

 

 

Important disclosures

Author

Luca Ferramosca
Portfolio Manager

Luca Ferramosca, CFA, is a portfolio manager with a focus on sovereigns. Prior to his current role, he worked as an institutional sales analyst at Aegon AM. 

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