ECB Watch: That was it!

One of the ECB's most controversial interest rate meetings brought a further interest rate hike of 0.25 percentage points, bringing the deposit rate to 4%. At the same time, it was signaled that, from today's perspective, a sufficiently restrictive level has now been reached. The focus is now shifting to the period until the first interest rate cut and the ECB's future liquidity provision.

Today's interest rate meeting was eagerly awaited, as it was unclear how the ECB Governing Council would resolve the conflicting signals from the economy and inflation. In the end, the hawkish faction prevailed. The ECB's interest rates were raised again by 25 basis points. The deposit rate is now at 4.0%, the main refinancing rate at 4.5% and the marginal lending rate at 4.75%. However, the ECB's key interest rates should now have reached a sufficiently restrictive level that will be maintained for a sufficiently long duration to contribute to a timely return to the inflation target, the ECB said. Balance sheet policy instruments were not changed at today's meeting. Maturing APP holdings will continue not to be reinvested, but PEPP holdings will be fully reinvested at least until the end of 2024. Targeted long-term refinancing operations (TLTROs) will mature as outlined. No new decisions were taken on minimum reserves either.

The focus was also on the updated economic forecasts. There have been some interesting developments here. The GDP growth forecasts have been revised downward, with the ECB now forecasting growth of only 0.7% in 2023 and 1% in 2024 (previously 0.9% and 1.5%). The reasons being monetary tightening on the one hand and the weakening international trade on the other. However, forecasts for inflation have been revised upward. The headline rate is now expected at 5.6% in 2023 and 3.2% in 2024 (previously 5.4 and 3.0%). A higher inflation contribution from energy prices was the key driver. The core rate was left unchanged at 5.1% in 2023 and even slightly lower in 2024 (2.9% instead of 3.0%).

In our view, the change in forecasts are not the decisive factor for the rate hike, as the underlying inflation outlook (core inflation) remained unchanged compared with June, while the growth outlook was weaker. Inflation "is still expected to remain too high for too long" was key. Considering that inflation is expected to fall significantly in the coming months and that the euro area economy should continue to deteriorate according to leading indicators, the window of opportunity for further rate hikes seems to be closed. And the ECB probably sees it similarly according to its communication. The ECB's communication was surprisingly clear and has significantly raised the hurdles for future rate hikes. However, the probable end of the hiking cycle does not necessarily mean an end to more restrictive measures. Balance sheet reduction will continue despite constant key interest rates, and an acceleration cannot be ruled out either.

On financial markets, the ECB decision represents a dovish rate hike. Bund yields declined along the yield curve and the euro depreciated. For the central bank, it will now be important to anchor its "higher-for-longer" promise in the market without further key rate hikes.

We will update our interest rate forecasts in a timely manner to reflect the new developments (in particular today's key rate hike).

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Franz ZOBL

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Franz joined Raiffeisen Research's Economics, Rates, FX team in 2020 primarily focusing on US monetary policy, benchmark yields and EUR/USD. Prior to joining RBI, he worked as a research economist in the financial sector. He holds a PhD from the London School of Economics and studied at the Vienna University of Economics, the University of Vienna as well as Tilburg University. He is a published author within the field of macroeconomics and has a passion for economic history.