Eurozone: With inflation a bother, ECB leaves the door open

Fed struck least hawkish tone of the hiking cycle.
Group Research, Radhika Rao05 May 2023
    Photo credit: Unsplash/Adobe Stock Photo

    The European Central Bank (ECB) hiked key benchmark rates by 25bp down from +50bp in Mar, taking the main refinance rate to 3.75% and deposit facility rate to 3.25%. This amounts to cumulative seven successive increases of 375bp, marking the most aggressive tightening cycle on record for the bloc. Notwithstanding the smaller scale of hike, the accompanying decision to stop reinvestments of its Asset Purchase Program (APP) from July is expected to assuage hawks in the Governing Council as this is tantamount to average EUR25bn monthly reduction in the portfolio.  

    Post policy commentary suggests that worry over inflation still has an upper hand on the path ahead, even as signs of tightening financial conditions surface in the latest bank lending survey. Apr inflation unexpectedly firmed up to 7% yoy (core at 5.6%) vs 6.9% in Mar, on the passage of energy-related base effects and stickier service inflation. Price readings are also being influenced by the scale of energy subsidies offered by the national governments, resulting in a divergence in readings across the member countries. Add to this, wage negotiations add to concerns over ‘underlying inflation’, including in Germany where the public sector recently secured a 5.5% rise for 2024 after agreeing to few tranches of tax-free payments this year, in addition to one-off increases last year to compensate for pressure on purchasing power. Minutes from the February meeting had highlighted that even as supply-side pressures ebb, corporate profits were rising as higher costs were being passed to selling prices, adding to domestic price pressures.

    ECB chief Lagarde’s insistence on the need for vigilance on inflation suggests a follow-up 25bp hike in June is likely. Beyond that, data-dependency would be prioritised, increasing the scope of a pause with tight policy settings. While they see no room for complacency, ECB’s De Guindos highlighted that the European banks were resilient because of their levels of capital, levels of liquidity and quality of the liquid assets, which will prevent spillover effects from the crisis in the US regional banks.

    Radhika Rao

    Senior Economist – Eurozone, India, Indonesia

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