SNAPSHOT2 min read

ECB: more work required to tame inflation

While interest rates are now in restrictive territory, inflation remains too high for comfort and borrowing costs have further to rise.

04/05/2023
ECB

Authors

Azad Zangana
Senior European Economist and Strategist

The European Central Bank (ECB) has raised all three of its key interest rates by a further 0.25%, bringing the deposit rate to 3.25%, the refinancing rate to 3.75% and the marginal lending rate to 4%. This is the first set of hikes that have not been half a percentage point in size, which would indicate that the ECB is close to ending its tightening of monetary policy.

However, president Christine Lagarde was at pains to emphasise at the policy decision press conference that “we [the ECB] are not pausing”, and that based on the staff projections in March, “…we believe that we have more ground to cover”. While being “data dependent”, it is clear that the Governing Council is not yet happy with the progress made in lowering inflation.

Lagarde also mentioned that past interest rate increases “…are being passed on forcefully”, and that the ECB’s recent Bank Lending Survey suggested that interest rates were now in restrictive territory. Banks have reported a fall in loan creation, owing to higher interest rates, but also lower demand in the economy.

The labour market continues to be resilient, as the latest unemployment rate estimate for March showed another fall to 6.5%. This was sighted as one of the upside risks to inflation. Should jobs growth continue to be stronger than expected, then demand and inflation pressures could persist.

Concerns over the stability of the banking sector were also raised, with reference to Silicon Valley Bank and Credit Suisse. While Lagarde sees a rise in tensions as presenting a downside risk, there was no immediate danger to act upon.

In addition to the rise in rates, the ECB also announced that it would be ending the re-investment of its assets held under the Asset Purchase Programme (APP) as of July. This is expected to shrink the ECB’s balance sheet by on average €25 billion per month, but would take 15 years to be fully wound down. Meanwhile, the Pandemic Emergency Purchase Programme (PEPP) would continue to be run down at a pace of €15 billion per month until next month. We expect an announcement in due course that would accelerate the run off in the PEPP from July onwards.

We expect the ECB to hike by another 0.25% in June, but the probability of further increases beyond then are smaller. If inflation continues to be more sticky, then a further rate rise in July could be on the cards. This would take policy into very restrictive territory, possibly even too restrictive, verging on a policy error.

Authors

Azad Zangana
Senior European Economist and Strategist

Topics

Follow us

Please note past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.

This marketing material is for professional clients only. This site is not suitable for retail clients.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.

Cazenove Capital is a trading name of Schroders (C.I.) Ltd which is licensed under the Banking Supervision (Bailiwick of Guernsey) Law 2020 and the Protection of Investors (Bailiwick of Guernsey) Law 2020, as amended in the conduct of banking and investment business. Registered address at Regency Court, Glategny Esplanade, St. Peter Port, Guernsey GY1 3UF (No.24546). Schroders (C.I.) Limited, Jersey Branch is regulated by the Jersey Financial Services Commission in the conduct of investment business. Registered address at IFC1, Esplanade, St Helier, Jersey, JE2 3BX, (No.31076).