Zona euro Actividad económica May 2023

Zona euro: ECB hikes rates by 25 basis points in May; rate hike cycle likely nears its peak

At its 4 May meeting, the European Central Bank (ECB) hiked the main refinancing operations rate, the marginal lending facility and the deposit facility rates by 25 basis points to 3.75%, 4.00% and 3.25%, respectively. The decision delivered the seventh consecutive hike—albeit the smallest of the series—and brought the cumulative increase since July 2022 to 375 basis points.

In a balancing act to appease both dovish and hawkish members of the ECB’s Governing Council—the latter favored a rise of 50 basis points—the Bank stated that it would stop reinvestments under its Asset Purchase Programme (APP) in July, which will lead to an average monthly reduction of EUR 25 billion in its asset portfolio. This reduction is tantamount to reducing money in circulation, which should reinforce tightening stemming from higher rates, thus helping to cap inflation.

The decision to continue hiking was due to stubbornly high core inflation, April’s uptick in headline inflation and the fact that “the inflation outlook continues to be too high for too long”. In March, the Bank released new inflation and growth forecasts: These predicted inflation of 5.3% this year, 2.9% in 2024 and 2.1% in 2025, while GDP is expected to grow 1.0% this year and by 1.6% in both 2024 and 2025.

The Bank again kept the door open to further hikes, stating that there is still “more ground to cover” and that it “stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term”. However, it added that “past rate increases are being transmitted forcefully to euro area financing and monetary conditions, while the lags and strength of transmission to the real economy remain uncertain”, anchoring future monetary policy decisions to a meeting-by-meeting and data-dependent approach.

Commenting on the ECB’s balancing act, Carsten Brzeski, global head of macro at ING, noted:

“Leaving aside the press conference, it will be hard for the ECB to return to 50bp rate hikes in the current macro environment with the lagged impact from previous hikes, banking turmoil and subdued growth but still-sticky inflation. In this base case scenario, it will be equally difficult to hike rates more than one or, at most, two times. In fact, the risk is high that every single additional rate hike from here could turn out to be a policy mistake further down the road. Instead, keeping interest rates high for longer after another rate hike in June will probably be the next compromise between the doves and hawks.”

Meanwhile, Lee Sue Ann, an economist at UOB, commented:

“The ECB clearly has every reason to stick to a data-dependent approach. Whether June or July will be the last will depend crucially on inflation data scheduled for late May, as well as from policymakers over the next few weeks. How the U.S. regional banking situation and debt ceiling negotiations pan out will also be key.”

The next monetary policy meeting is scheduled for 15 June.