Monetary policy of the European Central Bank
European stock markets started Monday with an uptrend. It was mainly investors who evaluated old macro data led by US inflation with the prospect of new macro data. Investors were also anxiously awaiting Thursday’s ECB decision on a new interest rate hike with great anticipation. Earlier in the week, global analysts were expecting a 40% probability of a 25 basis point rate hike, which became a reality when the European Central Bank announced the move. The ECB also said that this hike, which will be effective from September 20, 2023, could be the last one this year. Inflation continues to fall but is still expected to remain high for an extended period of time. The Governing Council is committed to ensuring a timely return of inflation to its 2% medium-term target.
The European trading market is ambivalent about the ECB’s interest rate hike decision. The odds of a rate hike versus rate stability were still roughly fifty-fifty as of Tuesday afternoon. By the evening, however, the situation had shifted more in favour of higher interest rates. This was thanks to unofficial sources close to the Governing Council who told Reuters that the updated forecast will show lower economic growth in 2023 and 2024, and in particular a higher inflation outlook in 2024 above the 3% seen in June. This in itself is said to be a reason to move the deposit rate to 4%.
According to the ECB’s macroeconomic forecasts for the euro area, average inflation is expected to reach 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. From 2025 onwards, inflation should start to fall more sharply. Upward inflation for this year and next year mainly reflects higher energy prices. The ECB analysts now expect the euro area economy to grow by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025. The Governing Council judges that the ECB’s key interest rates have reached a level that, by acting for a sufficiently long time, will contribute significantly to a timely return of inflation to target.
The new focus for the slowing economy will be on the industrial sector, where Germany plays a major role. Global analysts also think that rates are already at restrictive levels and that keeping them there for longer is in itself anti-inflationary. Reuters said via a press release that it expects a short-term strengthening of the euro and stronger demand for corporate and government bonds given the market outlook. The price of the euro against the dollar was at 1.0738 EUR/USD at 9:48 a.m. CET, Sept. 14, 2023.