Eurozone data suggests the ECB has to keep raising rates

The ECB faces rising political pressure to hold back on rate rises, but growth and inflation data suggest rates may yet have some way to rise.



Azad Zangana
Senior European Economist and Strategist

The European Central Bank (ECB) raised its key policy interest rates by 75 basis points again in its October meeting, taking the main refinancing rate up to 2%, and the deposit rate to 1.5%.

Although it was another large increase, the language that accompanied the change suggested that future hikes may be smaller. Instead of suggesting that the ECB was some way away from reaching an interest rate level consistent with returning inflation back to target, the committee decided to return to a meeting-by-meeting approach. This may be in response to rising political pressure, as higher rates have started to inflict pain on households and businesses.

French president Emmanuel Macron recently criticised further rate rises, saying they may “shatter demand” and worsen the recession.

Italy’s new prime Minister Giorgia Meloni also attacked the ECB in her maiden speech, saying that “a decision that many considered hazardous and which risks impacting bank credit to families and firms… [is] a rash decision”.

In addition to the rise in the main interest rates, the ECB also announced it was raising the cost of borrowing for banks which have been using the target long-term refinancing operations (TLTROs) – a set of loans provided to banks to ward off any liquidity issues during turbulent market conditions. Banks are being offered the change to repay those loans early, helping to reduce liquidity in markets.

ECB president Christine Lagarde responded to criticisms about the impact on growth by stating that “…we have to do what we have to do. We have to focus on our mandate. And our mandate is price stability”.

Regardless of this, investors took away the message that the ECB is becoming less hawkish, reducing the expected peak in interest rates from just over 3% before the meeting, to around 2.75%. The euro also depreciated against the US dollar in response.

Eurozone economies are slowing, but still showing growth

However, recent growth and inflation data suggests that the economy is holding up better than expected, and that interest rates may yet have some way to rise. Preliminary GDP figures are being released slowly, but there has already been a big surprise. Germany, which according to most business surveys is already in recession, beat consensus expectation by reporting +0.3% growth for the third quarter (q/q) against expectations of a 0.2% decline.

Although the economy slowed from the second quarter, Italy also beat consensus estimates, growing by 0.5% versus expectations of no growth. Elsewhere, the French economy slowed to 0.2% growth from 0.5% in Q2, while Spain also saw a slowdown, from 1.5% in Q2 to 0.2% in Q3.

Overall, eurozone GDP is estimated to have grown by 0.2% in Q3, matching consensus estimates, but slowing from 0.8% in the previous quarter. On a quarterly year-on-year basis, growth in activity has slowed from 4.1% to 2.1%.

As these are preliminary estimates, we have very little information at this stage as to the drivers of growth. We know that economies enjoyed a sharp rise in activity after Covid, especially those with greater dependence on tourism over the summer. Therefore, a slowdown was always expected. The French statistics authority does however publish a breakdown which offers some insight. Net trade in France was the main drag on growth, as the growth in imports outpaced exports. Household spending was flat, while investment accelerated, boosting domestic demand. However, there was a noticeable build-up of inventories, which suggests that demand is not keeping up with supply. This should eventually lead to a reduction in production, and potentially reduced demand for labour. These are early indications, but it seems that the French economy is starting to turn downwards.

Inflation continues to rise and spread

Eurozone inflation jumped to 10.7% year-on-year in October, much higher than consensus expectations of 10.2%. Energy inflation continues to be the main driver, up 41.9% y/y, but food, alcohol and tobacco rose sharply to 13.1%, and core inflation (excluding food, alcohol, tobacco and energy) also accelerated to 5%.

Inflation is becoming more widespread, and continues to surprise to the upside. With growth still holding up, and unemployment still near multi-decade lows, it is clear that without further tightening of monetary policy, a more serious inflation problem could develop, one that could take a decade to reverse.

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Azad Zangana
Senior European Economist and Strategist


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