Karsten Junius, chief economist at J. Safra Sarasin Sustainable Asset Management, considers why the ECB is likely to hold rates steady at its next meeting while keeping the door open to a September increase.
We expect stable policy rates at the ECB meeting next Thursday and no forward guidance for the September meeting – yet also a language that doesn’t reduce market expectations of a hike in September. The ECB is likely to highlight three key points: firstly, that oil prices have declined significantly since their last meeting, secondly, that the political situation in the Middle East remains unstable, and finally, that vigilance is needed as indirect effects of higher oil prices could become visible in core inflation in the coming months. Therefore, the situation should best be re-evaluated with the new macro projections in September. We expect a second rate hike this year in September.
Oil prices are currently close to the milder scenario of the ECB
Since the last policy meeting of the ECB, oil prices have declined significantly and so has headline inflation. Currently, Brent trades around 85 USD/barrel, which is close to the ECB’s “milder scenario” that incorporated an oil price of 88 USD/barrel. This is certainly a relief yet does not change the situation completely. It only reduces the probability of another hike at the meeting next week to almost zero and gives the ECB time to assess their economic scenario in September when new staff projections are produced. Importantly, the ECB has stressed that the policy rate hike in June would have been justified in all scenarios and was not just an insurance hike.
Economic data is stable enough to justify another rate hike
We expect the press conference of the ECB to focus on the medium-term prospects for policy rates. Officially, there has been little forward guidance. President Lagarde (“Honestly, I don’t know”) is trying to leave all options open, while Ms Schnabel, as so often, is more hawkish (“From today’s perspective, we will need to raise interest rates further in order to bring inflation back to our two percent target over the medium term. However, the extent and timing of further measures will depend on how the conflict, the economy and inflation evolve”).
To assess the need for higher policy rates to reduce aggregate demand, it is important to take into account how much higher oil prices already do so. The latest business indicators like the purchasing manager indices are normalising and so is consumer confidence. Surprisingly, even credit data are holding up much better despite a more muted Bank Lending Survey. In short, the European economy is growing robustly enough not to deter further interest-rate increases, should inflation demand them. We expect another rate hike in September.
