Europe braces for high-stake interest rate showdown

Christine Lagarde, ECB President, arriving at the 4 May ECB press conference in Frankfurt. Photo: ECB.

The upcoming meeting of the European Central Bank (ECB) promises to be one of the most consequential in recent times, underlining the difficult trade-offs the institution must consider amidst an environment of high inflation and stalling economic growth. Analysts and market watchers are sharply divided on what course of action the Governing Council will take on Thursday, making this meeting especially fraught with uncertainty.

On one side, the argument for an interest rate hike is compelling. Persistent inflation, currently at 5.3%, is far above the ECB's target of 2%. Franck Dixmier, Global CIO Fixed Income at AllianzGI, and Volker Schmidt, Senior Portfolio Manager at Ethenea, both underline that the markets seem unprepared for another rate increase, which they deem necessary due to the inflationary environment. Amanda Bergsma from Ebury lends additional weight to this argument by suggesting a 60% probability of a hike.

However, there is a counter-narrative that suggests caution. François Rimeu of La Française AM argues for rates to be kept unchanged, pointing to deteriorating growth indicators. Katharine Neiss at PGIM Fixed Income also expresses concern over the diminishing economic activity, highlighting a contraction in the industrial sector and signs of weakening in the services sector. The question thus arises: Would an interest rate hike now further endanger an already fragile economy?

Most uncertain

ECB President Christine Lagarde faces a precarious balancing act. Frederik Ducrozet from Pictet Wealth Management notes that this meeting is arguably one of the most uncertain in the ECB's recent history, given the lack of consensus among economists and the market pricing in only a 40% chance of a rate hike. Ducrozet suggests that despite recent official comments leaning towards a pause, there is still a high likelihood of a 25 basis point rate hike in September.

Simon Harvey of Monex Europe offers a nuanced viewpoint, arguing that the ECB has a narrow window for rate hikes before risking tipping the economy into recession. This perspective highlights the complexity and risk inherent in the current decision-making process.

Thursday's meeting will also be closely watched for changes in the ECB's inflation forecast. As Volker Schmidt suggests, any upward revision in inflation expectations, currently forecasted to be 3% in 2024 and 2.2% in 2025, would bolster the case for a rate hike.

Non-dovish tone?

With such a divided backdrop, Lagarde's communication strategy will also be pivotal. Rimeu anticipates that even if the rates remain unchanged, Lagarde will adopt a non-dovish tone, indicating that further tightening remains a possibility.

The ECB finds itself at a critical juncture where it must carefully weigh the immediate need to control inflation against the longer-term risks to economic growth. The decision, whatever it may be, will be read as an indicator of the ECB's evolving policy calculus in these turbulent times. The market, policymakers, and analysts alike will be keenly observing this meeting, anticipating that the decisions made will significantly impact the European economic landscape for the foreseeable future.

Mixed bag of expectations:

Simon Harvey Monex Europe hike to 4% and then hold
Katharine Neiss PGIM Fixed Income a pause could allow ECB to assess effects of rate hikes
Volker Schmidt Ethenea ECB has avoided giving clear expectation
Frederik Ducrozet Pictet hike to 4%, likelihood of a hike is underestimated
Franck Dixmier Allianz GI we still expect another interest rate rise 
François Rimeu La Française will leave interest rates unchanged due to worsening growth
Amanda Bergsma Ebury tentatively leaning towards a hike, assigning a 60% probability of a raise


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