Published on Monday, September 18, 2023

Europe | End of the cycle?

Unlike previous moves, which were clearly telegraphed to the markets, this time around there was considerable uncertainty over the ECB’s decision on interest rates: to pause or to hike? Notably, President Christine Lagarde’s press conference following the meeting revealed that the decision was indeed a split one.

Key points

  • Key points:
  • The ECB’s latest decision was complicated by the fact that economic indicators have been pointing to a rapid slowdown in growth of late, in the face of still high inflation and well above the target and heading toward the 2% mark much more slowly than Eurozone’s central bank would like. For some, the ECB was faced with a genuine dilemma.
  • However, given the central scenario of a gradual and transitory economic cooling and a desperately sluggish slowdown in inflation, the clear choice for a central bank, whose only mandate is price stability, was to hike interest rates.
  • The key issues moving forward are whether this hike marks the end of the cycle and, looking further ahead, when we can expect to see rate cuts. Regarding the former question, the ECB seems inclined not to raise rates any further.
  • First, because now they are more confident that with this move they will be successful in achieving the degree of monetary tightening needed for inflation to reach the 2% target in a timely manner. And second, because the ECB is confident that the transmission of monetary policy has been very efficient so far (faster than in previous cycles, although this is debatable). Given that the central bank’s decisions will continue to be data-dependent, what we can say is that if inflation surprise on the upside, we can expect to see further hikes.
  • Regarding the question of rate cuts down the line, the short answer is that they will take time to materialise. The ECB has been very clear on this: once rates eventually peak, they will be maintained for a sufficiently long duration. The markets —more concerned about the cyclical slowdown— are expecting rate cuts to start in mid-2024, although we do not expect this to occur until late 2024. After all, inflation will continue to set the tone.

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