Inflation has been “coming down” in Europe. That’s the good news.
The bad news: It’s “projected to remain too high for too long.”
So said the ECB in the very first sentence of the new policy statement. The bank raised rates by another 25bps on Thursday, as expected. That brings the cumulative tightening since July of 2022 to 400bps.
You’re reminded that the ECB started from negative territory. Thanks to ostensible constraints related to sequencing promises in the forward guidance, the first rate hike didn’t occur until headline inflation was already double target.
Headline price growth receded to 6.1% in May, the slowest YoY pace since Russia invaded Ukraine. Energy prices are obviously a big factor, and they’re still volatile. On Thursday, natural gas prices jumped as much as 30% on news the Dutch government is preparing to shutter Europe’s largest gas field within three months.
But core price growth remained near record highs at 5.3% last month. Services inflation ran at 5%. That’s a problem, and indeed the new staff forecasts, released on Thursday, found the ECB marking up their core inflation projections to 5.1% for 2023 and 3% for 2024. The growth outlook was revised marginally lower. (Recall that March’s forecasts were stale on delivery. They were completed prior to the banking stress in the US which, while unrelated to Credit Suisse, nevertheless served as the coup de grâce for the perpetually embattled Swiss mainstay.)
The ECB cited “past upward surprises and the implications of the robust labor market for the speed of disinflation” in explaining why staff expects core price growth to run 2.5 times target in 2023.
The bank was keen to emphasize that the tightening delivered thus far is having an impact on borrowing costs and loan growth. In Europe, at least, the tightening is making a difference, albeit not where it counts in terms of inflation. The ECB’s Q1 lending survey showed credit conditions remained tight and loan demand plunged amid higher rates. Broad money growth in Europe was the slowest since 2014 in March.
The new forward guidance didn’t contain an explicit promise for additional rate hikes, but Christine Lagarde later said the ECB is “not thinking about pausing.” Future decisions “will ensure that interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary,” the statement said. “The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction.” In essence, the question is whether the bank will keep raising rates after an assumed July increase.
“The fact that the ECB’s newest staff projections include an upward revision of both headline and core inflation across the entire time horizon must have strengthened the case for continued hiking,” ING’s Carsten Brzeski remarked. “Still, with the Fed’s hawkish pause and a eurozone economy not only turning out to be less resilient than anticipated but also facing a very subdued growth outlook, the ECB is increasingly taking the risk of worsening the economic outlook.”
The ECB confirmed that APP reinvestments will cease altogether next month (i.e., APP QT will accelerate from July). There was no change, though, to the PEPP forward guidance. Principal payments from maturing assets the ECB accumulated as part of its pandemic QE program will be reinvested “until at least the end of 2024.”
“It is very likely the case that we will continue to increase rates in July,” Lagarde told reporters on Thursday. “Which probably doesn’t come as a big surprise to you.”
