Our view: the peak in the ECB’s deposit rate is likely this week
Much like in June, the question on Thursday seems not to be whether the European Central Bank (ECB) will hike (we think they will by 25bps), but whether or not this hike will be the last. The bank has been clear in its communications that decisions will be data-dependent from the September meeting onwards; it appears there has been little new information to convince the ECB that additional hikes in September and beyond will be necessary.
Hawks’ main concerns remain wages and core inflation. Labour markets remain too strong for policymakers to take much comfort from core inflation approaching a potential peak. While more timely wage data have shown some plateauing, the trend remains upward. While we are perhaps getting the first signs that employment growth is stalling in Germany and Spain, it is all very tentative thus far.
Although June’s euro area inflation print proved to be a downside miss relative to expectations, on revision core inflation was in line with expectations – not the fillip the lower preliminary reading suggested.
When taken in conjunction with the downside miss on PMIs, and especially in services PMIs, September remains an open decision. If anything, the data appear to have softened the hawks’ tones: the number of hawkish versus dovish comments from ECB Governing Council members in recent weeks has become a lot more balanced.
A balanced view
We expect the narrative in the statement and the press conference to reflect this balanced view and continue to state data dependency. Unless data surprise to the upside between now and the September meeting, the Council is likely to want to pause to assess the impact of both the substantial hikes to date and the recent acceleration in liquidity roll-off, with quantitative tightening (QT) moving from €15bn per month to closer to €30bn.
We believe QT is likely to accelerate further, but that this is unlikely to come before the new year at the earliest. Weak lending data already provide some evidence that rates are already restrictive and biting.
The minutes of the June meeting also offered some hints that the hurdle for more hikes may be rising. There were some concerns raised that June’s inflation forecast – this time aggregated from national central bank forecasts – was on the high side. This had also been a hawkish surprise to the market when published, signalling a rising concern within the Council about the path of inflation when comparing to the ECB’s March forecasts. The minutes also showed discomfort with focussing solely on core inflation at the expense of broader measures of inflation, which are now clearly on a downward trajectory.
If there is anything new worrying the ECB, it is more likely to be the external rather than internal developments, in our view.
Trouble next door
Neighbouring countries have experienced further inflation upside surprises (e.g. in both Sweden and Norway, albeit the upside surprise in the UK in May has since been offset in the June data) and additional rate hikes – 25bps from the Riksbank and 50bps each from the Norges Banks and the Bank of England. Further afield, the Bank of Canada hiked again, and the US Federal Reserve signalled that they are not done with hikes, although the latter was known at the time of the last ECB meeting.
This reminds us that even central banks in more interest rate-sensitive economies have been dragged back to hiking rates because of labour market conditions and stickier inflation outcomes.
Our forecast remains that the peak in the ECB’s deposit rate is likely to come this week, but that risks remain skewed to the upside. This week’s meeting is unlikely to provide us with much new information: we will have two more inflation reports and two more labour market reports ahead of the September decision, which will guide whether more hikes are delivered in Q4.
The shift in the tone of recent comments from members of the Governing Council is also likely to mean that any discussion on further acceleration of QT is put on ice.