ECB Set To Slow Hike Pace After Core Prices Ease: Decision Guide

(Bloomberg) -- The European Central Bank is poised to slow the pace of interest-rate increases after its preferred inflation measure eased for the first time in 10 months.

With tighter lending conditions also weighing on the economy, officials will raise the deposit rate by a quarter-point to 3.25% on Thursday, according to money-market investors and most economists in a Bloomberg survey.

A bigger move can't be ruled out, however: A minority that includes JPMorgan Chase & Co. and Bank of America reckons officials will opt for a 50 basis-point step as underlying price gains still far exceed the 2% target and wage growth is picking up.

Goldman Sachs said the quarter-point it predicts isn't a “foregone conclusion.”

Officials are increasingly flagging that the most aggressive bout of monetary tightening in ECB history is approaching its conclusion, with markets and analysts foreseeing two more hikes beyond this week before rates settle at 3.75%.

A downshift today would match the quarter-point increase that the Federal Reserve delivered on Wednesday.

What Bloomberg Economics Says...

“The ECB will probably announce a 25 basis-point increase. Recent comments indicate support for a larger move has a narrow base. A stabilization in underlying inflation and signs that credit conditions are tightening have probably convinced policymakers that the time for a downshift from 50 basis-point hikes has finally arrived.”

— David Powell, senior euro-area economist. Read the full note here

The ECB will make its announcement at 2:15 p.m. in Frankfurt, with President Christine Lagarde to face the press half an hour later.

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Interest Rates

Hawkish members of the Governing Council may yet maintain their focus on core inflation, which strips out food and energy prices and, at 5.6%, remains near a record high.

A compromise over a smaller rate increase could include a signal that borrowing costs must still rise further — even if the ECB has only recently begun to heed its own mantra of taking decisions “meeting by meeting.”

JPMorgan economist Greg Fuzesi expects any guidance to be “relatively loose,” in line with the ECB's greater adherence to incoming data, and be more hawkish if a smaller increase materializes.

There could also be a push to offload more quickly the stack of bonds the ECB bought in the past as stimulus.

Economic Outlook

Officials will debate a trove of economic reports that have landed in the past week and been left without public comment due to the quiet period preceding ECB decisions. 

On the one hand, the dip in core inflation alongside weaker-than expected output in the 20-nation euro area at the start of 2023 support the view that the price shock is fading. That's backed up by indications that lenders are curbing credit as rate rises work their way through the system and in the wake of the recent unrest in the financial sector. 

On the other hand, however, surveys of purchasing managers point to robust activity in the services sector. Wages are also picking up more strongly, raising concerns that inflation will be harder to beat back than initially feared. 

The question is whether any of the data have shifted the ECB's assessment of the economy and, subsequently, how much higher it still needs to push rates.

Quantitative Tightening

The ECB started shrinking its roughly €5 trillion ($5.5 trillion) pile of bonds by €15 billion a month in March. That hasn't caused ruptures in financial markets, raising expectations that reductions will quicken after June, when the existing rolloff pace is reviewed. 

Executive Board member Isabel Schnabel said last month that the goal is to completely phase out reinvestments under the Asset Purchase Program, with precise timing to be decided “soon.”

Officials may also debate ongoing repayments of long-term loans offered to banks at attractive conditions, a €477 billion tranche of which falls due in June. No alternative measures have been flagged so far, but recent banking stress means the ECB will be monitoring the situation closely to see if any tensions emerge in the system.

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