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Over the past year, the European Central Bank (ECB) has consistently indicated that interest rates would rise. However, this week they surprised the market by raising rates by a quarter percentage point and eliminating their forward guidance on further rate hikes, similar to the US Federal Reserve’s approach. ECB president Christine Lagarde stated that their next policy meeting in September could see either a rate increase or a pause. This shift in tone from both the ECB and the Fed has led investors and analysts to believe that interest rates in the US and eurozone have reached or are close to their peak.
Konstantin Veit, a portfolio manager at Pimco, expressed the view that while the ECB may raise rates further, they are nearing their peak. This sentiment is supported by declining inflation numbers in both the US and the eurozone. In the US, inflation dropped to 3% in June, while in the eurozone it fell to 5.5%, with further declines anticipated in July. Anna Stupnytska, global macro economist at Fidelity International, noted that the tightening measures are impacting the eurozone’s credit channel and real economy.
The eurozone’s economy is also weakening, as evidenced by stagnant output in the past two quarters and expectations of tepid growth in the second quarter. Surveys indicate a downturn in private-sector activity, leading to concerns about further weakness in the third quarter. Erik Nielsen, chief economic adviser at UniCredit, stated that the convergence of data and sentiments indicates a shift towards a more dovish stance.
In contrast, the US economy is performing better, with GDP growth of 2.4% in the second quarter surpassing expectations. Federal Reserve Chair Jay Powell highlighted the potential need for further tightening to control inflation, but acknowledged that the full impact of their tightening measures is yet to be felt.
Lagarde stated that the ECB remains open to the possibility of additional tightening, but emphasized that it would depend on the data. Key factors to consider include consumer price growth figures for July and August, as well as the ECB’s inflation forecasts. Dirk Schumacher, an economist at Natixis, predicted that falling inflation in the eurozone would make further rate hikes less likely.
In terms of inflation, Lagarde provided a balanced outlook, citing potential upward pressures from Russia’s grain export deal with Ukraine and the climate crisis. However, she also noted that the eurozone’s economic outlook has deteriorated, particularly due to weak domestic demand, which should help reduce price pressures. Claus Vistesen, an economist at Pantheon Macroeconomics, considered the shift in stance expected given recent poor economic data, but suggested that wage growth figures for the second quarter could offer one last opportunity for ECB hawks before a more dovish approach is adopted.
Additional reporting by Colby Smith.
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