Eurozone rates: ECB hikes to address inflation, drops hint on path ahead
Inflation concerns continued to outweigh weakness in activity indicators for the European Central Bank (ECB), with the recent resurgence in oil prices likely magnifying the policy dilemma. The Governing Council raised the main refinance rate and deposit facility rate for the tenth consecutive time on Thursday, taking these to a record high of 4.5% and 4% respectively. The decision to tighten further was backed by upward revisions in inflation projections for 2023 to 5.6% from 5.4% earlier and 2024 to 3.2% from 3% earlier. The medium-term forecast for 2025 was nudged down to 2.1% from 2.2%. Even as the projections for core inflation were trimmed, the view that headline and core would stay above the ECB’s target this year and the next was likely seen as out-of-sync with its price stability goals. Reflecting the impact of domestic and global headwinds, the growth forecast was lowered to 0.7% (DBSf: 0.6%) from 0.9% previously for this year and 1% from 1.5% for next year. Earlier in the week, the European Commission had set the high inflation-weak growth backdrop, expecting German output to contract -0.4% this year, before rising to 1.1% in 2024 vs 1.4% in the May update. For the bloc, above-target inflation, aggressive rate hikes, soft real wages, slowing China, and geopolitical headwinds have overwhelmed benefits from a tight domestic labour market. On the path ahead, President Lagarde’s remarks that “interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” can be construed to mean that rates might have peaked, but policy will be kept restrictive for an extended period of time to tame price pressures, putting to rest any hopes for a reversal in the policy direction towards easing. We expect the policy rates to be held unchanged for rest of the year and 1H24, before switching to a growth-supportive stance in the second half.
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