When to raise rates? The ECB scenarios so as not to be late as in 2018

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 When to raise rates?  The ECB scenarios so as not to be late as in 2018

Once assimilated that the rise in interest rates seems inevitable in the euro zone due to high inflation, the European Central Bank (ECB) debates the timing of the rise. “Some time after” the end of the shopping program, is the reference issued by President Christine Lagarde on the first rate hike. However, the precision on the exact date and the rhythm, is key for the economy of the Eurozone. The ECB has in its hand to set the course before the consequences of the current scenario worsen and normalization arrives late due to the risk of recession. Negative rates -the main interest is at 0% and the deposit facility at -0.5%- have been in place since 2014 and were not tightened even in 2018, when the Fed did so to prevent the US economy from shrinking. will reheat

The fear now is to go back. If the ECB barely offers a hike of 25 basis points until December, the slowest scenario, there is a risk that “slowing credit growth and capital flight out of the eurozone will force it to restart net asset purchases, combined with new specific long-term refinancing operations“, highlights an ING report.

Regarding this situation, the investment firm Rentamarkets affirms, in statements collected by Europa Press, that one of the “problems that gives the most fear” is that the ECB “makes the same mistakes that have been made and goes back into another ‘policy mistake’, after the one he made in 2018 not being able to normalize rates“. A) Yes, Ignatius Strongpartner and investment director of the firm, points out that “when you have high inflation and monetary policy remains very accommodative, in the end there is a monetary devaluation”, something that has already happened in Turkey or Japan in recent weeks.

Faced with this risk, ING analysts see as a base scenario a rise in interest rates 25 basis points in Septemberonce the bond purchase program ends in the second quarter, and would add another 25 basis points in December. “In this scenario, the ECB will make a clear distinction between policy normalization, i.e. ending net asset purchases and negative deposit rates; and policy tightening, i.e. raising rates to take them to a more neutral level.

The high inflation in the euro zone, which in March already reached 7.4%, could force the ECB to take a more ‘aggressive’ path. If the purchases end next June, the first rate hike could take place in July (+25 basis points) and a similar one in September. According to the forecasts studied by ING, given that the ECB’s decisions are conditional on its projections, the central bank also “could start raising rates with a movement of 50 basis points in September.” In any chaos, in this scenario, with the supply and energy crisis still unsolved, monetary normalization would take rates at 2% in 2024.

This situation is not ruled out. This Thursday, the vice president Luis de Guindos left the door open to raising rates in July as long as the upcoming June forecasts and data developments support it: “From today’s perspective, July is possible and September or later is also possible“. Along the same lines, the Belgian Governor Wunch, the German Joachim Nagel and the latvian Martins Kazaks. Wunch even went so far as to say that the ECB could move its interest rates above zero before the end of the year, which has led rate markets to forecast three 25 basis point hikes by the ECB this year. Lagarde, for her part, reiterated that we will have to wait until June to act.

The forecasts condition the evolution of the euro against the dollar

While waiting for the path chosen by the ECB, the price of the euro against the dollar is trading with fluctuations after a drop of more than 4% since January. The latest comments from the monetary authority of the euro zone give a slight boost to your currency. This week it accumulates three consecutive increases, but it is still insufficient to recover from the minimum since May 2020 that marked last week after the monetary policy meeting. The euro remains below $1.09 and its weakness in the euro “comes on top of the upside risks to inflation and implies that a negative deposit interest rate may no longer be necessary”, highlights Silvia Dall’Angelo, an analyst at Federated Hermes.

Commenting on ING, the analysts stated that “much of the ECB’s tightening is already priced in and we prefer to support the dollar this year. We doubt short-term EUR/USD gains near or above 1.10 will be sustained. Still, in 2023, they believe Fed easing expectations could see the dollar flip and EUR/USD end the year at 1.15.

The attempts of ‘comeback’ of the European currency against the US are diluted by the expectations of a more aggressive monetary policy by the US Federal Reserve (Fed). The downward trend of the euro has been going on since 2021, when the Fed already began to anticipate a rate hike.

The US central bank, with Jerome Powell at the forefront, made its first rate hike since 2018 in March and expects to continue doing so in upcoming meetings, with increases that can reach 50 basis points according to part of the market and confirmed by Powell himself this Thursday during the meeting with Lagarde. “I would say there will be 50 basis points on the table for the May meeting”, he predicted. The aggressive position of the American contrasts with that adopted by Lagarde, who urged to wait for the June economic forecasts of the ECB to act.

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