The European Central Bank is almost certain to raise interest rates again on Thursday and forecast further hikes in the coming months, with the size of the hikes in doubt.
The ECB has been raising rates at a record pace to combat a sudden outbreak of high inflation in the Eurozone, a byproduct of factors such as the aftermath of the COVID-19 pandemic and the energy crisis following Russia’s invasion of Ukraine.
The central bank of the 20 countries that share the euro is expected to raise its deposit rate another half percentage point to 2.5% on Thursday, in line with what it said in December.
With this, the rate that the ECB pays on bank deposits would reach its highest level since November 2008, after a steady rise from the historical low of -0.5% registered in July.
But ECB President Christine Lagarde is sure to face questions about smaller hikes starting next month, after the U.S. Federal Reserve slowed the pace of its own hikes on Wednesday and some data pointed to a gloomier outlook for the euro zone.
The Federal Reserve raised interest rates again and said more hikes were needed, but also acknowledged that it had passed a turning point in inflation and that disinflation was underway, comments that encouraged stock markets.
Lagarde has so far rejected any suggestion that the ECB is relenting in its fight against inflation and investors expect her to reaffirm this argument on Thursday, an expectation that pushed the euro sharply higher overnight.
“We suspect the ECB will reiterate its aggressive message in February, as there are still uncertainties about underlying inflationary pressures and a change in tone would undermine the ECB’s credibility,” said Annalisa Piazza, fixed income research analyst at MFS Investment Management.
In December, the ECB said it would raise rates “at a steady pace” until it was satisfied that inflation was returning to its 2% target.
However, this stance is being a source of controversy within the Governing Council as headline inflation falls, although core price growth continues to rise and is broader.
Hawks (supporters of aggressive monetary policy) who advocate raising rates, such as the Dutch Klaas Knot, the Slovakian Peter Kazimir and the Slovenian Bostjan Vasle, have explicitly called for further increases of 50 basis points in both February and March.
However, supporters of loose monetary policy, such as Greece’s Yannis Stournaras and Italy’s Fabio Panetta, have advocated smaller hikes, or at least for the ECB to refrain from committing in March.
This tension could lead to a middle ground in the language used, as happened in December, suggesting that the size of its next rate hike will depend on incoming data, analysts say.
“Probably emboldened by the resilience of the Eurozone economy, the ECB will not be swayed by the decline in headline inflation brought on by energy and will focus directly on core inflationary pressure,” said UniCredit (BIT:CRDI), which expects signs of a 50 basis point hike also in March.
BNP Paribas (EPA:BNPP), for its part, believes that the ECB could eliminate the reference to a “constant pace” of rate hikes or compensate for it, so that a rise of 50 basis points “would not be predetermined, but would remain a possible outcome.”
The latest economic data paint a mixed picture.
Headline inflation has fallen rapidly since hitting an all-time high of 10.6 percent in October, but core prices, which exclude volatile items such as food and fuel, have risen steadily or accelerated.
The Eurozone recorded unexpected growth in the last three months of 2022, although this was largely due to an exceptionally mild winter and Ireland’s excellent results.
And an ECB survey showed that banks were restricting access to credit to the greatest extent since the 2011 debt crisis, usually a harbinger of slower growth and slowing inflation.
Financial markets expect the ECB’s deposit rate to peak at 3.5% in the summer, the highest level since the turn of the century.
The ECB is also about to reveal how exactly it plans to reduce the billions of euros of bonds on its balance sheet, undoing some of the asset purchases it made to boost inflation during nearly a decade when it was too low.
Barclays analysts (LON:BARC) estimate that the €60 billion of maturing bonds that the ECB will not renew between March and June will be roughly split equally between government and other debt, including corporate and guaranteed bonds, as well as asset securitisations.