The European Central Bank (ECB) began its 2-day policy meeting today and will announce its interest rate decision on Thursday. Market expectations have swung in recent weeks from nearly no chance for a 25 bp rate hike on Thursday to a better than 50-50 chance of a rate hike, highlighting just how much uncertainty surrounds the decision.
At the beginning of this month, markets were discounting the odds at only 20% for a +25 bp rate hike by the ECB at Thursday’s policy meeting after weaker-than-expected economic reports signaled a slowdown in the Eurozone economy. However, that view has changed rapidly in recent weeks as evidence builds that the Eurozone is facing persistent inflation. The odds for a 25 bp rate hike jumped to 66% today after a report from Reuters said that the ECB's new economic estimates, due to be released Thursday, will show a Eurozone inflation forecast for 2024 above 3%.
In the face of sticky inflation, Some ECB policymakers hinted that the ECB may continue to tighten monetary policy. Last week, ECB Governing Council member Knot warned that investors were “maybe” underestimating the likelihood of an increase in borrowing costs. Despite Eurozone Aug core CPI easing to +5.3% y/y from +5.5% y/y, it is more than double the ECB’s 2% target. However, some analysts believe signs of economic weakness will nevertheless force the ECB to pause its rate hikes. Toronto-Dominion Bank said they expect the ECB to hold rates steady after Thursday’s meeting.
Today’s weaker-than-expected Eurozone economic news bolsters the case for the ECB to hold pat on interest rates after Eurozone Jul industrial production fell -1.1% m/m, weaker than expectations of -0.9% m/m and the biggest decline in 4 months. Also, a Bloomberg report today said that Germany’s Economy Ministry is set to downgrade its growth estimates for this year, projecting a -0.3% contraction in 2023 German GDP from an April forecast for +0.4% growth. In its monthly report today, the German Economy Ministry said, “Overall, current economic indicators do not yet point to a sustained recovery in the coming months.”
Despite signs of slowing economic growth, the ECB may be forced to raise interest rates on stagflation risks. Last week’s monthly ECB consumer inflation expectations survey showed inflation expectations for the next 12 months in July remained unchanged at 3.4%, well above the ECB’s 2% target. Comments made last week from ECB Executive Board member Schnabel suggest she favors a rate hike even in the face of slowing growth after she said that part of the current economic slowdown may reflect long-term shifts rather than cyclical forces such as lower demand. Andromeda Capital Management Ltd said the ECB is in a “lose-lose” situation if it raises rates or stands pat on Thursday, given the stickiness of inflation.
On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
