ECB raised key rates by 25 bps in its September monetary policy decision to 4.50%, taking the closely watched deposit facility rate to 4.00%, in line with markets thoughts. The Euro broadly weakened and European yields generally fell. The bank’s staff new inflation projections incorporate the recent run-up in energy prices supported the hawks’ view that more tightening was needed, countering the doves who likely pointed to downward revisions to GDP growth and core inflation forecasts as a reason to hang off with raising rates further.
Today’s rate hike is most likely the last from the ECB in this cycle, with rates reaching “levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” A key addition “for longer” guidance that prevented a less neutral/more dovish read of the decision. APP/PEPP changes were not discussed in the statement.
ECB Monetary Policy Decision September 14, 2023
- Main refinancing rate at 4.50% vs 4.25% prior expected 4.50%
- Deposit facility rate 4.00% vs 4.00% expected Prior 3.75%
- Marginal lending facility 4.75% Prior 4.50%
Highlights
- ECB says that “based on their current assessment” they consider that “the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”
- The upward revision to inflation forecasts was a clear trigger for today’s rate increase, a hike that may not have come without the surge in energy prices since late-June.
- The new headline inflation forecasts face upward risks considering the increase in oil prices since late-August.
- The bank has expanded on the ‘for longer’ part of the story. A “sufficiently long duration” of rates at this level could do the job, so no more increases may be needed; says Lagarde.
- Lagarde could not say that they are at the peak, but seemed to indicate that the focus will be on duration of peak rates but that both level and duration matter.
The optionality on more hikes remains, considering the “current” part of the assessment. Recall that this cycle has challenged central banks to come back and do more than they thought months prior. Instead of watching another round of data before the October 26th decision, including the ECB’s quarterly bank lending survey, the Governing Council erred on the side of caution today rather than risking a six-week wait and realizing next month that they’ve underdone it. Inflation “is still expected to remain too high for too long”, so more increases cannot be ruled out.
ECB Projections September
- The staff’s new projections of inflation that incorporate the recent run-up in energy prices supported the hawks’ view that more tightening was needed today.
- A convenient leak to Reuters Tuesday night had already readied the upwards revision to the 2024 inflation forecast, which now sits at 3.2% from 3.0% in the June round (2025 lower, at 2.1% from 2.2%).
- Note that the quarterly path still shows two-handled inflation at Q4-24, remaining at the 2.9% pace projected in June.
- The doves (“some” which preferred a pause versus a “solid majority” for a hike, according to Lagarde) likely pointed to negative revisions to GDP growth forecasts as a reason to hold off on raising rates further.
- Growth projections went from 0.9% to 0.7% and 1.5% to 1.0% in 2023 and 2024, respectively.
- 2023 GDP at 0.7% (previously 0.9%)
- 2024 GDP at 1.0% (previously 1.5%)
- 2025 GDP at 1.5% (previously 1.6%)
- 2023 inflation at 5.6% (previously 5.4%)
- 2024 inflation at 3.2% (previously 3.0%)
- 2025 inflation at 2.1% (previously 2.2%)
Market Reaction
- Markets had priced in with a maximum of 25bps cumulatively seen by the December meeting; the 8bps ‘surprise’ relative to expectations and 2bps have now been added to year-pricing for a remaining ~40% chance that the ECB hikes again.
- A very brief jump in European yields and the EUR was followed by a sharp leg lower on a closer read of the statement that gave a more dovish than neutral view of the decision (certainly not hawkish).
- German 10s show a clearer reaction to the decision, falling 6-8bps vs pre-decision, compared to about a 2bps move lower in 2s that have had to absorb at least some of the full 25bps hike versus the 17bps priced in.
NB LTRO (Targeted Longer-Term Refinancing Operations) is best described as a long term loan to banks to increase loan creation. The banks lend above a specified benchmark and borrow from the ECB at a negative rate. This will provide an incentive for the banks to lend and thus increase private spending in the economy. That’s the theory clearly has not been a great success so far.
Full Statement by the ECB 14 September 2023
Monetary policy decisions
14 September 2023
Inflation continues to decline but is still expected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. In order to reinforce progress towards its target, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points.
The rate increase today reflects the Governing Council’s assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The September ECB staff macroeconomic projections for the euro area see average inflation at 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025. This is an upward revision for 2023 and 2024 and a downward revision for 2025. The upward revision for 2023 and 2024 mainly reflects a higher path for energy prices. Underlying price pressures remain high, even though most indicators have started to ease. ECB staff have slightly revised down the projected path for inflation excluding energy and food, to an average of 5.1% in 2023, 2.9% in 2024 and 2.2% in 2025. The Governing Council’s past interest rate increases continue to be transmitted forcefully. Financing conditions have tightened further and are increasingly dampening demand, which is an important factor in bringing inflation back to target. With the increasing impact of this tightening on domestic demand and the weakening international trade environment, ECB staff have lowered their economic growth projections significantly. They now expect the euro area economy to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.
Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, the Governing Council’s interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.
Key ECB interest rates
The Governing Council decided to raise the three key ECB interest rates by 25 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 4.50%, 4.75% and 4.00% respectively, with effect from 20 September 2023.
Asset purchase programme (APP) and pandemic emergency purchase programme (PEPP)
The APP portfolio is declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.
As concerns the PEPP, the Governing Council intends to reinvest the principal payments from maturing securities purchased under the programme until at least the end of 2024. In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.
The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.
Refinancing operations
As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.
The Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and to preserve the smooth functioning of monetary policy transmission. Moreover, the Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries, thus allowing the Governing Council to more effectively deliver on its price stability mandate.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:45 CET today.
The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:45 CET today.
Alternate player (audio: en,fr,de) Watch on Twitter @ECB
Live. https://www.ecb.europa.eu/home/html/index.en.html
Source: European Central Bank
From The TradersCommunity Research Desk