This document is a marketing communication.

ECB Watch: Will I do it again, or is the hiking cycle finally ending?

Can ECB manage to push through its tenth rate hike in a row, will the hawks in the Governing Council prevail? A rate hike on Thursday would be a (market) surprise, but is within the realm of possibility and could be argued. However, an interest rate "pause" would end the hiking cycle, in our view. The window of opportunity to push forward hikes should close soon, given economic slack in the euro area.

Hawkish consistency or dovish procrastination?

To raise key rates again this week or not, that will be the crux of the matter in the ECB Governing Council this Thursday. In principle, we see the two options (1) last and tenth rate hike in a row by 25 basis points or (2) unchanged key rates as almost equally likely scenarios (with a slight bias into the direction of no hike). Above all, if there will be no hike this time around, then further hikes are unlikely to be an option. The strategy of an announced pause in interest rates and a later increase does not seem credible to us in view of the rapidly deteriorating economic outlook for the euro area. For this reason, the hawks within ECB's Governing Council will try to add another notch to the current interest rate cycle and consistently tighten monetary policy further. Especially since the all-clear on the inflation front cannot yet be given completely, which is indicated not only by still high price growth data, but also by market-based inflation expectations.

Inflation pricing on capital markets: short & long term

5YF5Y inflation expectations: long-term forward EUR inflation swap

Source: Refinitiv, RBI/Raiffeisen Research
Source: Refinitiv, RBI/Raiffeisen Research

However, depending on how one looks at it, the doves in the Governing Council can also point to some marginal improvements in the dataset, such as the stabilization or slight declines in core inflation. Such differentiated considerations and assessments are of particular importance considering current monetary policy decisions, which are explicitly data-driven. ECB's own fresh forecasts (economic growth, inflation), which will be published on Thursday, will also play a weighty role. This applies above all to the 2024 inflation forecasts. In June, the ECB projected euro area inflation at 3% in 2024 (headline and core inflation), and at 2.2% and 2.3%, respectively, in 2025 (the latter core inflation rate). However, there is a risk that core inflation will be significantly higher than headline inflation in 2024. The ECB may need to take this risk assessment into account in its projections.

Euro area: Core inflation (% yoy)
Source: Refinitiv, RBI/Raiffeisen Research

There are currently three essential criteria for data-driven decision-making at the ECB:

1) Underlying inflation: inflation rates at the euro area level have not surprised since the last interest rate meeting, which means that underlying price pressures — despite some decline in headline inflation — have only eased very slowly. At 5.3% year-on-year, core inflation continues to be far from ECB targets, moving only slightly away from highs around 5.5% to 5.7%. Notable easing in core inflation is possible from the turn of the year at the earliest.

2) Inflation outlook: It can be assumed that ECB's inflation estimates (according to June projections) will hardly change to the better. What will be important are the forecasts for core inflation, where the last ECB forecast set still painted a rather optimistic disinflation picture. Either way, inflation forecasts (headline and core inflation) should remain above ECB targets until 2025. This should be reason enough for some Council members to vote for a hike. Central bank governors from countries such as Austria, Slovakia and partly Germany have publicly positioned themselves in favor of a further hike. The fact that 8 countries in the euro area currently still have above-average inflation of over 7% (including Austria, Slovakia and Croatia) may play an indirect role here. Some forecasters even expect inflation rates above 4% in the euro area in 2024 (maximum forecast consensus 4.7%), which the ECB could interpret as a warning signal. Market-based inflation expectations also do not signal any easing at present and could be interpreted as a risk indicator (de-anchoring of inflation expectations).

Inflation rates euro area countries (HICP, % yoy)
Number of countries in each inflation bucket*
* Currently eight countries with inflation rates above 7%; data as of August 2023, black line euro area average inflation at 5.3% yoy

3) Strength of monetary policy transmission: Economic data have surprised negatively since the last rate setting meeting. Fresh ECB forecasts are likely to bring a downward revision to 2023 GDP estimates (June estimate: 0.9%). Given the subdued newsflow with regard to business cycle dynamics in recent days (after the cutoff date for forecast preparation), even the lowered ECB GDP estimates are likely to be subject to downside risks. Last, monetary indicators should be noted. Relevant indicators point very clearly to the fact that the monetary tightening to date has led to a significant downward dynamics in the money and financial sectors. The partly negative development of outstanding money and credit will dampen economic activity and inflation with the usual time lag. After cooling considerably in recent months, almost as much as in the aftermath of the global financial crisis, euro area M3 growth was in negative territory in July for the first time since 2010, a manifest indicator of the extent of monetary tightening and drastic toughening of financing conditions. This is especially true given the role played by unwinding of unconventional monetary policy instruments, which are currently reinforcing monetary tightening and its impact on the European banking sector compared with previous interest rate hike cycles.

Does ECB seek to surprise hawkishly - or route of least resistance?

As outlined, we believe that the upcoming ECB meeting will bring the last "good" opportunity for a rate hike. Economic developments we expect by the end of the year (very weak economy, falling inflation, collapsing demand for credit) will quickly close the window for higher key rates. ECB will probably subsequently move to emphasize elevated / restrictive key rates for a longer period and shift the focus to other important steering instruments (balance sheet policy). On financial markets, an interest rate hike is hardly expected at present. According to the latest surveys (Bloomberg, Reuters), about half or slightly more than half of the analysts do not expect any interest rate hike or expect a pause in interest rates (51% and 55%, respectively). The EUR exchange rate movement of the last few days and weeks also does not necessarily point to interest rate fantasy in the euro area. A hike this week would be definitely a hawkish surprise. Thus, ECB's Governing Council will also have to consider whether it wants to be good for a certain (market) surprise once again — as it has done on several occasions in the current cycle — or not. After all, the current monetary policy cycle — despite high interest rate market volatility — has passed without any major market tensions. This could give ECB some confidence to play against interest rate expectations of market players. Moreover, in our view, market-based inflation expectations would even justify a rate hike. However, further rate hikes could also fuel the debate about alleged "excess profits" in the European banking sector and, from a political perspective, could again require further "compensation mechanisms". And here, ECB is not fully in line with all measures set at the national level (keyword: bank taxes).

In light of such considerations and the probably divided opinion in the Governing Council, a non-increase this week seems to us rather the dominant strategy from a political economy perspective. Overall, the decision of not raising rates this time should be rather an easy one to take. This would then be the starting signal for the important next debate in the Governing Council: High key rates for how long, falling key rates from when?

Profile pic


location iconAustria   

Gunter Deuber is heading the Economics and Financial Analysis division (Raiffeisen Research) at Raiffeisen Bank International (RBI) since 1 January 2021. Since 2011, Gunter Deuber has held leading positions in RBI's Economic and CEE Research and has continuously expanded the cooperation with his research colleagues in RBI’s subsidiary banks in CEE. Since the early 2000s, he has been analysing economies, banking sectors and market topics with a focus on CEE and EU/euro area topics for RBI in Vienna, but also in the international (investment) banking context in Frankfurt. He regularly presents the views of Raiffeisen Research and his research team at meetings with investors and clients. He is a well sought-after speaker at landmark events in the finance and banking industry and a guest lecturer at several universities/teaching institutions. In 2019, he was nominated for the US State Department's IVLP (International Visitor Leadership Program). Gunter has published several edited volumes on Euro/EU crisis issues and published various articles in professional journals and industry magazines. Outside the office, Gunter enjoys travelling with his family and long-distance running.

Profile pic

Gottfried STEINDL

location iconAustria   

Gottfried Steindl leads the department for economics, rates and FX analysis. For more than 20 years, he has been representing Raiffeisen Research's view of economic and financial market developments to clients and he has worked as a lecturer at the FHWien and a trainer at the Raiffeisen Campus. For his economic forecasts, he has been listed in the top field by Bloomberg for years. Gottfried Steindl was educated as an economist at the Vienna University of Economics and Business Administration and at the Institute for Advanced Studies and holds a CIIA and CEFA diploma. He enjoys passing on his enthusiasm for economics and financial markets at presentations. Gottfried spends his free time with his family doing as much sport, music and travelling as possible.