Euro Area: ECB delivers another 25 basis point hike in July but strikes more dovish tone

Euro Area Monetary Policy July 2023

Euro Area: ECB delivers another 25 basis point hike in July but strikes more dovish tone

At its 27 July meeting, the European Central Bank (ECB) hiked the main refinancing operations rate, the marginal lending facility and the deposit facility rates by 25 basis points to 4.25%, 4.50% and 3.75%, respectively. The decision, which was widely expected by markets, delivered the ninth consecutive hike and brought the cumulative increase since July 2022 to 425 basis points. Moreover, the ECB decided to stop remunerating banks for the money they are mandated to keep at the institution as a minimum reserve in a bid to improve the monetary-policy transmission mechanism.

The decision to continue hiking was underpinned by expectations that inflation, even if on a downtrend, would remain above target for an extended period. Moreover, underlying inflation remains too high. June saw headline inflation fall to 5.5% from May’s 6.1%, while in the same month, inflation excluding energy and food rose to 5.5% from 5.3%. The ECB stated that inflation “is still expected to remain too high for too long”.

The Bank tweaked its forward guidance, keeping the door open to further hikes but also suggesting the possibility of a pause. It stated that interest rates would be brought to levels that were sufficiently restrictive to hit the 2.0% target in the medium term. To this end, the Bank reiterated it was “ready to adjust all of its instruments within its mandate”. That said, in the accompanying press conference, President Lagarde stated that “the September meeting will be deliberately data-dependent”, adding that the change of wording “is not just random or irrelevant”.

The next meeting is scheduled for 14 September.

Commenting on the ECB’s decision, Carsten Brzeski, global head of macro at ING, noted:

“We think that the ECB is not yet done with hiking rates, but a pause has become fashionable amongst central banks, which had been ahead of the ECB in their hiking cycles. In fact, the ECB’s own growth and inflation projection in September will have to see a significant downward revision in order to stop the Central Bank from hiking rates at least once more after today.”

Conversely, Lee Sue Ann, economist at UOB, expects the ECB to have delivered its last hike on 27 July:

“Just like the ECB, we hold an ‘open mind as to what the decisions will be in September and in subsequent meetings’; though for now, we are keeping to our view of a pause in the current tightening cycle, implying terminal rates of 4.25% and 3.75% for main refinancing operations and the deposit facility, respectively.”

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