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The European Central Bank has been clear over the past year that interest rates were only heading in one direction: up. This week that changed.
The ECB raised rates by a quarter percentage point on Thursday, but it dropped guidance that borrowing costs would keep rising, just as the US Federal Reserve had done a day earlier.
ECB president Christine Lagarde confirmed after the meeting that the rate-setters’ ninth-rise in a row could be the last, saying that at its next policy meeting in September the ECB could raise rates or pause. “It’s a decisive maybe,” Lagarde said, summing up its more neutral approach.
On Wednesday, Fed chair Jay Powell had been similarly ambiguous. He said after its well-trailed quarter-point rate rise that, while it was “certainly possible” it would lift borrowing costs again in September, it was also “possible that we would choose to hold steady at that meeting”.
Investors and analysts have taken the rhetorical shift as a clear signal that rates in both the US or the eurozone were now at — or close to — their peak.
Konstantin Veit, a portfolio manager at bond investor Pimco, said: “Today’s meeting reiterates our view that, while the ECB might increase interest rates further, we feel it is approaching cruising altitude.”
The data support the shift. Inflation has been falling for months on both sides of the Atlantic. In the US it hit 3 per cent in June, while it dropped to 5.5 per cent in the eurozone and a further dip is expected when price growth numbers for the bloc in July are released on Monday.
“We are seeing clearer signals of the transmission mechanism working through the system in the euro area, as tightening continues to move through the credit channel into the real economy,” said Anna Stupnytska, global macro economist at investor Fidelity International.
The single currency area’s economy is also weakening fast.
Output has stagnated in the past two quarters and is expected to have grown at best tepidly in the second quarter when GDP figures are published on Monday. There are fears of further weakness in the third quarter after surveys of purchasing managers and banks this week pointed to a sharp downturn in private-sector activity.
“Pipeline inflation is coming down, and eurozone GDP looks outright ugly now,” said Erik Nielsen, chief economic adviser at Italian bank UniCredit. “So, the sensible middle has finally lined up with the doves.”
The US economy is performing better. Fed staff on Wednesday ditched their forecast of a recession this year and US GDP outstripped expectations by growing 2.4 per cent on an annualised basis in the second quarter.
Powell warned that US economic resilience may mean more tightening is needed to tame price growth, saying “stronger growth could lead over time to higher inflation”. Though he added: “We have covered a lot of ground and the full effects of our tightening have yet to be felt.”
Lagarde said on Thursday that the ECB would “have an open mind” on whether more tightening is needed. “The burden of proof is going to be on the data,” she said, while raising the possibility of the ECB skipping a meeting before resuming rate rises later, as the Fed did last month.
Much will hinge on consumer price growth figures for July and August, as well as on the ECB’s own forecasts for inflation due out directly after its meeting in September concludes. But Lagarde said it would also examine numbers on the labour market, investment and inflation expectations.
Dirk Schumacher, an economist at French bank Natixis, forecast eurozone inflation would keep falling, making more rate rises unlikely. “I take at face value the ECB’s switch to an open-minded stance on whether it will hike rates again,” he said.
Lagarde gave a balanced view on the inflation outlook. Russia’s withdrawal from a deal allowing Ukraine to export grain from its ports on the Black Sea could create “renewed upward pressures” on food prices, she warned, as could “the unfolding climate crisis”. Higher-than-expected growth in wages or profit margins could also keep inflation high.
But she said the eurozone’s near-term economic outlook had “deteriorated, owing largely to weaker domestic demand”, adding this should reduce price pressures, especially if combined with falling energy prices.
Claus Vistesen, an economist at consultants Pantheon Macroeconomics, said the shift was “hardly a surprise given how quickly they have tightened, and the flow of poor economic data in the past month”.
But he said the potential for “nasty” second-quarter wage growth figures would still “offer the ECB hawks a final moment of glory in September before they are put back in their box”.
Additional reporting by Colby Smith
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