Review: ECB raises rates and signals July hike amid inflation concerns

The European Central Bank (ECB) made a decisive move at its June meeting by raising interest rates 25 basis points. The central bank also provided a clear signal that another rate hike is on the horizon for July. This action underscores the ECB's commitment to tackling the issue of rising inflation. However, the lack of any indication regarding a potential pause in rate hikes has left the financial markets speculating about the duration of the current hiking cycle.

Commitment to restrictive levels for inflation control

The ECB's statement emphasized its determination to bring key interest rates to sufficiently restrictive levels. The aim is to achieve a timely return of inflation to the medium-term target of 2%. The wording used in the statement remained largely unchanged from May, reinforcing the central bank's steadfast approach to its objectives. However, the statement did not provide any insight into when the peak of rate hikes might be reached. Instead, it reiterated the ECB's data-dependent approach in determining the appropriate level and duration of restriction.

Confirmation of July hike, uncertainty for September

During the subsequent press conference, ECB President Christine Lagarde confirmed the central bank's plan to raise rates again in July. However, she refrained from providing any hints regarding the ECB's intentions for September. Prior to the meeting, the financial markets had priced in a 72% probability of a 25-basis-point increase next month. Nevertheless, there was little expectation of tightening in September.

Reassessing inflation outlook in September

Fresh forecasts to be released in September will provide the Governing Council with an opportunity to reassess its outlook on inflation. It is our belief that core inflation will ease more rapidly than currently anticipated by the ECB. This projection is based on the ongoing decline in contributions from core goods and the moderating impact of headline inflation on earnings growth.

Marginal downgrade in growth projections

The ECB marginally revised down its growth projections for 2023 and 2024 compared to the figures published in March. The revised growth forecasts stand at 0.9% for 2023 and 1.5% for 2024, indicating a slightly weaker-than-expected performance in the earlier part of 2023. These revisions likely reflect the incorporation of more downside risks into the previously optimistic forecasts. However, the magnitude of the revisions was smaller than anticipated.

Upward revision in medium-term inflation outlook

In contrast to the growth projections, the medium-term outlook for inflation was revised upward. This was despite taking into account likely upward revisions to market expectations for policy rates compared to the projections formulated in March. Both the headline and core inflation forecasts for 2025 were increased, with figures of 2.2% and 2.3% respectively.

Substantial revisions to core inflation projections

Projections for core inflation underwent significant revisions across the forecast horizon. Notably, the figure for 2024 was raised to 3.0%, exceeding both our own forecast and consensus expectations, which currently stand at 2.7%. Lagarde confirmed during the press conference that these revisions were primarily driven by a stronger labor market and higher wage growth.

The path ahead: Interest rates and inflation

Considering the signs, it appears highly likely that a 4.25% interest rate will materialize in July, setting the stage for the final interest rate. We continue to view the final interest rate as having upside risks. Whether it reaches 4.5% in September remains uncertain and contingent on the data. The ECB may remain unconvinced of a substantial deceleration in core inflation by the time of the September meeting. However, if economic fundamentals remain stable and the Federal Reserve maintains its hawkish stance, the possibility of the ECB surpassing the 4.25% mark in the fourth quarter could become a reality.