Lagarde’s ‘heavy words’ hint at long plateau for rates

ECB President Christine Lagarde at Thursday's press conference in Frankfurt. Photo: ECB via Flickr CC-BY-2.0.

The European Central Bank is most likely done hiking interest rates, analysts said following the decision in Frankfurt to raise its three benchmark eurozone interest rates by 25 basis points. Euro bond markets rallied while the euro fell against the dollar amid expectations that eurozone rates now have peaked and that any subsequent move in market interest rates will be a cut, although that may take some time.

Inflation in the eurozone is still expected to remain too high for too long, said the ECB when explaining its decision to boost its main deposit rate to 4%, the highest level since the euro was introduced in 1999. Looking ahead, the ECB said that rates now are at a level where they can make a significant contribution to bringing down inflation towards the medium-term target of 2 percent.

Key ECB interest rates “have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” the central bank said. “The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary.”

Clarity appreciated

Eurozone bond markets rallied amid expectations that peak eurozone rates will open the door for higher bond prices and lower market interest rates. The yield on the ten-year German government bond, the eurozone benchmark, was as much as 9 basis points lower at 2.56 percent during Thursday’s trading. The euro fell to 1.07 against the dollar, its lowest level in three months.

Expectations of analysts and market strategists had been mixed ahead of the ECB meeting as the central bank had not given clear guidance on what to expect from its September decision. 

‘Dovish hike’

Frederick Ducrozet, head of macroeconomic research at Pictet Wealth Management, said he believes that the eurozone now has achieved its peak in interest rates for the current cycle. “A dovish hike insofar as guidance suggests this will be the final one,” he tweeted. “At peak rates the focus will be on policy transmission, and how long rates need to stay at this level.”

At German private bank Berenberg, chief economist Holger Schmieding said there is a “long plateau” ahead during which policy rates will stay high. “This clarity about the outlook may be more important than today’s 25bp increase,” he said. From now on, the focus of the ECB debate will shift to the length of the likely rate plateau. “The ECB will probably stay put next year,” he wrote, adding that the ECB may lower market rates to 3.5% in 2025.

Anna Stupnytska, global macro economist at Fidelity International, said elevated core inflation, combined with higher oil prices, meant the ECB could not afford to wait and see. “With what is very likely to be the last hike of this cycle now out of the way, the ECB is now going into wait-and-see mode, while still preserving optionality,” she said in a note.

“The focus for markets will shift to how long rates will be kept at these restrictive levels - this will of course depend on the inflation and growth trajectory from here… the ECB might have to execute a fast course correction in 2024, but for the time being their guidance is likely to focus on the ‘higher-for-longer’ scenario.”

‘Heavy words’

Lagarde said the specific text in the ECB statement on maintaining interest rates at the current level was “a key paragraph” with “heavy words”. 

“With today’s decision, we have made sufficient contributions under current assessment, to returning inflation to target in a timely manner,” said Lagarde. “And as I said, both elements matter, the level - sufficiently restrictive - and the duration, but it’s obvious that the focus is probably going to move a bit more to the duration. But it is not to say, because we can’t say that we are at peak.”

Berenberg’s Schmieding, in a note to investors, said Thursday’s rate hike adds downside risk to its projection of an economic rebound called for early next year.

The ECB’s next monetary policy meeting is scheduled for 26 october in Athens.

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