What will the ECB decide on 14 September
Forecasts and scenarios on the ECB meeting scheduled for 14 September. Analysis by Tomasz Wieladek, Chief European Economist, T. Rowe Price
WHAT THE ECB WILL DO ON 14 SEPTEMBER
We expect the ECB to take a break at its next meeting, based on the recent round of data which should push for greater caution. A hike, in the presence of data that begins to signal a recession, could be counterproductive: if the ECB surprises investors with a hike, markets could start to price in a policy mistake, easing financial conditions and expecting a weaker euro. This would make monetary policy less restrictive, increasing imported inflation: it would be the opposite of what the ECB wants to achieve.
THE WORDS OF LAGARDE
In a press conference last July, President Christine Lagarde declared that the ECB would be guided mainly by data to evaluate, if necessary, an increase in September. Governing Council members stuck to this communication strategy and most policymakers' speeches left the September outcome hanging. Following the transition to a primarily data-based rate setting strategy, markets assessed the possibility of a rate increase only on the basis of the evidence emerging from the indicators.
WHAT THE DATA SAY
However, the latest data clearly points to a pause in September. The services PMI weakened significantly in August, continuing the streak of negative surprises that began in May. This is important, as the services PMI shows a high correlation with the actual growth of services in the euro area, even after the pandemic, while other surveys appear to have lost the predictive power on the real economy that they once had.
INFLATION DOSSIER FOR THE ECB
On the inflation front, the core version of the consumer price index (CPI) surprised the consensus on the upside last July, but underwent a marked reversal in August, both on an annual and year-on-year basis. The monthly core CPI index in the euro area had remained at the levels of an average August, before the recent increase in inflation. Finally, the strength of Eurozone growth in 2Q 2023 has faded, weakened by net exports, but supported by inventories. Household consumption remained virtually unchanged in the first half of the year. Based on this recent batch of data, markets are pricing in only a 30% chance of a rally this week.
THE EUROZONE TOWARDS RECESSION
I have long held the view that we are probably sliding into a recession in the Eurozone. It is not yet the dominant view, but it is gaining more and more consensus among economists and markets, following last week's revisions to GDP data.
THE MOVES OF THE FED AND ECB
In her speech at Jackson Hole, President Lagarde informally defined three conditions for a pause in rate increases. The ECB needs to see: the transmission of monetary policy to the real economy, a turning point in underlying (core) CPI inflation and a 2% inflation outlook (forecast) in the medium term. The data shows that the first two conditions are clearly met. The forecast (the third condition) is decided by the ECB. However, weakening growth data is expected to lead to a lower inflation forecast in ECB models.
THE RISKS OF FURTHER RATES RISE
In fact, there is a risk that a rise this week could backfire. By refraining from commenting on the September decision, policymakers encouraged markets to price policy on data alone. And the data points to a pause. If Governing Council membership were to increase regardless, in the current environment of weak real economic data and an emerging recession, markets could start to price in a policy mistake. The fact that the ECB is making hikes in what is starting to look like a recession could push markets to price in further cuts in one to two years. The euro would depreciate rather than appreciate. This would effectively ease financial conditions, implying a less restrictive policy. The euro would likely continue to depreciate, increasing imported inflation. There is therefore a real risk that a rise this week could prove counterproductive.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/che-cosa-decidera-la-bce-il-14-settembre/ on Thu, 14 Sep 2023 05:04:30 +0000.