By
Bhushan Akolkar
January 3rd, 2024
As inflation slows, the European Central Bank (ECB) may halt future rate hikes, with the upcoming staff projections and rate decision playing a crucial role in determining the bank’s approach.
Central banks across the world have been hiking interest rates in order to tame the soaring inflation. However, as inflation shows signs of slowing down, the European Central Bank (ECB) could soon bring an end to future rate hikes.
The ECB is likely to increase its benchmark policy by an additional 25 basis points this week. However, it insists that all future rate hike decisions would be strictly data-dependent amid the current uncertainty with the future growth outlook and inflation.
In a research note to clients, Fritzi Köhler-Geib, a chief economist with German bank KfW, said:
“Weaker economic data, the significant easing on the energy markets and the recent surprisingly sharp drop in inflation argue for an early end to the interest rate cycle. On the other hand, growing wage pressure and falling but still high inflation expectations call for caution.”
Recent data on inflation indicates that prices are slowing down, but they are still increasing at a high rate for consumers. The headline inflation rate is at 6.1% year-on-year, and the core rate is at 5.3%. This level of inflation is concerning for officials in Frankfurt, especially with wages continuing to rise. Therefore, the upcoming staff projections from the ECB, which will be released on Thursday along with their rate decision, will be important in assessing the situation. In a research note, Mark Wall, an ECB watcher at Deutsche Bank, said:
“The risks [for the terminal benchmark rate] are tilted to the upside of 3.75%”. The bank’s benchmark rate is currently at 3.25%. “Inflation was below consensus in May but underlying inflation is still high and we expect upward momentum from tourism-related pricing in the summer. The ECB may have to wait until September and possibly later before it has robust evidence that underlying inflation is slowing enough to skip or pause the hiking cycle.”
QT Discussions Take a Back Seat
As per the CNBC report, discussions around the quantitative tightening as well as an acceleration of shrinking ECB’s overall balance sheet will likely be out of the discussions between policymakers this week.
Last month in May, the policymakers also announced that they would stop reinvestments as part of their Asset Purchase Program (APP) from July 1. Started in mid-2014, APP is a bond-buying stimulus package that deals with persistently low inflation levels.
The top priority will be the direction of the economy and where it’s heading as the European Union slipped into a technical recession during the second quarter of this year. However, the growth picture has a lot of uncertainties into it. Although the sentiment has improved over the last six months, it’s yet to reflect on the hard data. In a research note, Natixis ECB watcher Dirk Schumacher said that “the lack of any clear sign of acceleration of the euro area economy could be explained by the fact that new clouds are rising at the horizon – just as the old ones have vanished. While companies report ‘equipment as a limiting factor’ being less of a problem in expanding production, a weakening of demand is increasingly seen as a problem.”
Read other market news on our website.