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19 June, 2024
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ECB dilemma with core inflation at 5.5%

Weaker data may impact growth forecasts


By Salomon Fiddler

The European Central Bank (ECB) is almost certain to raise interest rates by 25 basis points in its meeting tomorrow, though what happens next is unclear. We estimate a 60% probability of a similar move on September 14, which would set the refinancing rate at 4.5% and the deposit rate at 4%, up from the current 4% and 3.5%, respectively. However, weaker economic data, like the decline in the composite Purchasing Managers' Index (PMI) in the Eurozone, suggests that the ECB is more likely to keep borrowing costs unchanged in September. Like many other central banks, the ECB is approaching the end of its rate-hiking cycle. Yet next year, it may take an extreme step. While the Fed and the Bank of England may start cutting rates in early 2024, we expect the ECB to maintain rates at their higher levels for an extended period.

The ECB is likely to refrain from giving a clear direction regarding rate hikes in its meeting, choosing instead to adopt a wait-and-see stance based on economic data. This aligns with recent comments, even from the most aggressive in approach, such as Klaas Knot, the President of the Dutch Central Bank, who stated that rate hikes beyond July are "by no means certain." Factors that the ECB's governing council will consider include the general inflation rate and core inflation, both of which were at 5.5% on an annual basis in June, well above the official target. While inflationary pressures are easing and the nominal interest rate could decline to 3% by the end of 2023, the ECB is likely to avoid jeopardizing progress against inflation by ending the tightening cycle too early. In September, the ECB will have two more crucial pieces of information: the inflation figures for July and August, as well as updated macroeconomic forecasts. Nevertheless, the real economy shows signs of weakness, and the ECB would like to avoid a recession. This prospect favors a cautious pause, waiting for risks from wage increases to recede. The ECB may need to downgrade its optimistic growth projections for September. Currently, it expects GDP to increase by 0.9% in 2023 and 1.5% in 2024, significantly higher than Bloomberg's estimate of 0.5% and 1% in 2024.

Mr. Salomon Fiddler is an economist at Berenberg Bank.

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