La Française: To hike or to pause? It's a close call, but we're betting on the latter!
We expect that the Governing Council (GC) will leave interest rates unchanged at the September meeting due to worsening growth. It is a close call considering market pricing, current inflation levels, and rising oil prices, but we believe that ultimately, they will choose to stay on hold at this meeting.
We expect the European Central Bank (ECB) to:
- Maintain the deposit rate at 3.75% and the Refi rate at 4.25% given weakening growth and slightly slowing underlying inflation.
- Continue with a meeting-by-meeting approach with the possibility of maintaining or raising rates after September. President Lagarde will emphasize the ECB’s dependence on incoming data for subsequent meetings.
- Reaffirm that the ECB will keep policy rates in restrictive territory for a longer period to ensure inflation converges to the ECB's 2% target.
- Reiterate that the outlook for inflation is uncertain. Price pressures and wage increases remain, but risks are viewed as more balanced. President Lagarde will highlight that underlying inflation has likely passed its peak.
- Potentially signal that the ECB will begin discussions on an earlier end to Pandemic Emergency Purchase Programme (PEPP) reinvestments. They will need to strike a balance in their press conference by incorporating some hawkish elements to satisfy hawkish members.
- Indicate lower growth rates in 2023 (revised downwards from 0.9% to 0.7%) and 2024 (from 1.5% to 1.3%) due to weaker demand. We anticipate that growth will remain unchanged at 1.6% in 2025.
- Revise inflation upwards in 2023 by 0.2% and downwards in 2024 by 0.1% while keeping 2025 unchanged.
In summary, we expect the ECB to maintain an overall tightening bias despite the pause. During the press conference, President Lagarde will make strong efforts to avoid a dovish communication, clearly indicating that further tightening is possible. This meeting may result in a modest steepening of the yield curve.