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ECB to hike rates twice as inflation remains hot

REUTERS/Kai Pfaffenbach
ECB chief Christine Lagarde urged governments to help the central bank by withdrawing support measures put in place at the height of the energy crisis

The European Central Bank (ECB) will hike its key interest rates by 25 basis points (bps) at each of the next two meetings, according to economists polled by Reuters, many of whom also said the bigger risk was rates could go higher still in the future.

Several ECB policymakers have reiterated the central bank may need to raise interest rates for longer than previously thought until underlying inflation shows significant signs of cooling.

The ECB, which slowed to a 25 bps hike at its May meeting after a series of 75 and 50 bps moves, was expected to raise its deposit rate again by a quarter of a percentage point next month to 3.50 percent, according to all 62 economists polled on May 10-15.

Although 20 respondents predicted the ECB to end its tightening cycle there, a majority, 42, saw the rate climbing to 3.75 percent in July with five of them expecting it to touch four percent in September.

Medians then showed rates unchanged at 3.75 percent until at least next April. Only one forecast a 25 bps cut this year.

“The messaging from several ECB speakers has clearly been on the hawkish side since the (May 4) meeting and their consumer expectations survey just showed higher inflation expectations,” noted Ruben Segura-Cayuela, Europe economist at Bank of America.

“Unless something breaks, we can only reiterate our view that – despite the cracks appearing in the outlook – two more 25 bps hikes are the lower bound.”

While the ECB began its hiking cycle later other major central banks, it is now one among a few with more hikes to go.

In contrast, the US Federal Reserve raised its benchmark overnight interest rate by 25 basis points earlier this month and signaled a pause to the tightening cycle.

But ECB president Christine Lagarde said the ECB was ‘not Fed-dependent’ and would not pause as rates were not yet ‘sufficiently restrictive’.

Core inflation

As inflation continues to run well over three times the ECB’s two percent target, all but one of 28 respondents said the bigger risk was the peak interest rate could be higher than they currently expect.

Headline price pressures were not expected to fall to the ECB’s two percent target until at least 2025. Core inflation was predicted to average 5.5 percent, 5.0 percent and 3.9 percent in Q2, Q3 and Q4 respectively and average 2.7 percent in 2024.

“Given its importance to ECB policy prospects, the trajectory of core inflation is pivotal to the euro zone’s economic and financial outlook,” said Ken Wattret at S&P Global Market Intelligence.

“In the short term, with the ECB signalling it has ‘more ground to cover’, the risk is to the upside. The hiking cycle could extend into Q3 given still elevated core inflation, the record low unemployment rate and growth resilience.”

A recession was looking distant, with a 40 percent probability of one within two years, giving the ECB room to take rates higher and observe the lagged effects of its previous increases.

The 20 bloc economy was expected to grow 0.2 percent in the current and next two quarters on a quarterly basis, averaging 0.7 percent this year before rebounding to 1.0 percent next year.