European Central Bank Raises Interest Rates to Record 4%, but Economists Predict Peak
The European Central Bank (ECB) made a significant move by increasing interest rates to a record high of 4%. However, economists believe that this hike may mark the peak and are now questioning how long the rates will remain at this level. Both the Federal Reserve and the Bank of England are expected to have at most one more hike in their plans before finishing. Despite these measures, inflation is not projected to reach the central banks’ target of 2% until 2025, which indicates further challenges for households and potential risks to the economic outlook.
The ECB’s Governing Council signaled its belief that rates may have already reached their highest point. While the statement does not completely rule out further hikes, it suggests that the current level of rates, if maintained for a significant period, will contribute to the timely return of inflation to the target.
The short-term outlook for inflation remains grim, and this will likely impact households’ financial well-being. The ECB’s staff projects that inflation in the euro area will average 5.6% this year and 3.2% next year. However, the forecast for 2025, which is closely monitored, has been revised down from 2.2% to 2.1%.
Economists, including Holger Schmieding from Berenberg, anticipate that discussions will now focus on how long the rates will remain at the current level. Deutsche Bank analysts predict no rate cuts before September 2024, implying a 12-month pause at 4%.
Despite these projections, there are challenges on the horizon. One potential risk is the possibility of significantly higher oil prices, which could impact goods costs and inflation expectations in both Europe and the United States. Raphael Thuin, head of capital markets strategies at Tikehau Capital, warns that there is an alternative scenario where inflation remains strong and resilient, suggesting the potential for further rate hikes.
The Federal Reserve has been clear about its intentions for further hikes, expressing concerns about a fresh acceleration in inflation if financial conditions ease. While the June forecast does not anticipate inflation reaching 2.1% until 2025, monthly data highlights ongoing price pressures, particularly driven by energy prices.
Market expectations for the Federal Reserve include holding rates steady in September, with uncertainty about another hike later this year. However, economists at J. Safra Sarasin believe that the relatively strong economic data and persistent inflation will maintain a hawkish bias. The updated dot plot released quarterly by Fed policymakers may include a final hike by the end of the year.
Markets anticipate rate cuts by the Federal Reserve next year, but some argue that this may be premature. Economists in a Reuters poll predict the first cut to occur either in the first quarter or the second quarter of 2024.
As for the Bank of England, expectations are for one final hike in September. The monetary policy committee weighs inflation of 6.8%, signs of stress on the economy, and renewed conversations about a potential recession. The Bank expects inflation to reach 5% by the end of this year, halve by the end of next year, and finally reach their 2% target in early 2025.
Marcus Brookes, chief investment officer at Quilter Investors, believes that the Bank of England is no longer in a clear space where interest rate hikes are essential. Weak gross domestic product data for July supports this view. BNP Paribas analysts anticipate a final “dovish hike” in September due to wage growth, inflation pressures, and softening activity indicators.
The job market also shows signs of cooling, with unemployment rising by 0.5 percentage points. Furthermore, the mortgage market remains weak, with payments in arrears reaching a seven-year high in the second quarter. Expected price growth and wage growth have fallen, and fewer companies report difficulty finding staff.
While a November hike is possible, James Smith, a developed markets economist at ING, suggests that a pause is more likely, given the direction of the dataflow and recent comments from the Bank of England.
In summary, although the European Central Bank has raised interest rates to a record high, economists believe that rates may have peaked. The focus now shifts to how long rates will remain at this level. Inflation is not expected to reach the central banks’ target until 2025, posing challenges to households and potential risks to the economy. The Federal Reserve and the Bank of England are also anticipated to make at most one more hike before concluding their plans. The outcome of these monetary policy decisions will greatly impact the economic landscape in the coming months and years.