ECB expected to slow pace of tightening

Chris Scicluna
Emily Nicol

ECB expected to slow pace of tightening to 25bps on tighter credit conditions
The ECB seems bound to follow the Fed with further tightening at lunchtime today. But, in line with the consensus, we expect the pace of rate hikes to slow to 25bps, taking the deposit rate to 3.25% and the cumulative increase this cycle to 375bps.

We don’t entirely reject the possibility of another hike of 50bps today. While it was more than 3½ppts off its peak, Tuesday’s flash estimate of consumer price inflation in April of 7.0%Y/Y was still too high for the Governing Council’s comfort, particularly as the core rate (5.6%Y/Y) was a mere 0.1ppt off the series high and services inflation continues to rise.

But like the Fed yesterday, the case for a more measured approach from the ECB relates to the recent tightening of credit conditions, also laid bare in Tuesday’s data, and the lagged effects of the significant hikes already implemented, which have yet to be fully felt. With much weaker evidence in the euro area than elsewhere that high inflation is persisting due to excess demand, the ECB needs to be careful not to overdo the tightening.

In terms of forward guidance, we expect the Governing Council to repeat that future decisions will be data-dependant and rely in part on the updated macroeconomic projections due next month. We would not be surprised, however, if President Lagarde gave a signal in her press conference that a further hike in June is more likely than not.

While no decision on quantitative tightening is likely today, we do expect a signal that the pace of balance sheet shrinkage is also more likely than not to accelerate from July on.

Fed raises rates by 25bps, but signals that the peak might have been reached
As had been widely expected, the FOMC yesterday raised interest rates for the tenth consecutive meeting, by 25bps taking the Fed Funds Rate target range to 5.00-5.25%, the highest in sixteen years and taking the cumulative tightening this cycle to 500bps. The FFR target range is now bang in line with the FOMC’s median dot-plot forecast for year-end published in March.

The Fed’s economic assessment was little changed from March, noting that activity had expanded at a modest pace, job gains had been robust and inflation remains elevated. But the Committee accepted that tighter credit conditions are likely to weigh on growth, jobs and inflation

Of most significance was what Powell acknowledged was a “meaningful” amendment to the Fed’s forward guidance, with the policy statement no longer noting that the FOMC “anticipates that some additional policy firming may be appropriate”. Rather, the Committee noted that it will assess a range of factors including upcoming economic data and the lagged effects of the cumulative tightening “in determining the extent to which additional policy firming may be appropriate”.

While Powell didn’t rule out the possibility of future rate hikes, the tone of his press conference was certainly more dovish and strongly signalled that a pause, and possible end, to the tightening cycle in June is likely. Please see Daiwa America economist Lawrence Werther’s wrap-up of yesterday’s meeting here.

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