Central bank

Uneasy ECB, Earlier Hikes

26 April 2022 • 3 mins read
Uneasy ECB, Earlier Hikes
  • The European Central Bank is set to lift interest rate earlier now with its quantitative easing likely to end in the summer and the first hike in its -0.50% deposit rate due as early as July.
  • First, officials seem increasingly uneasy about record inflation. ECB hawks have been joined by centrist Governing Council members in calling for rate hikes to start in Q3’22 now.
  • Second, the impact on Eurozone growth from the war in Ukraine has so far been less severe than feared according to April’s purchasing manager indices (PMIs) and German IFO data.
  • The ECB could delay its first rate hike if the EU bans Russian gas but a July start looks likely and may temper USD strength against the EUR.

The European Central Bank is set to lift its -0.50% deposit rate from as early as July now - rather than our previous forecast of December - after the ECB ends quantitative easing in the summer.

Eurozone Inflation

Source: Bank of Singapore, Bloomberg.

First, officials seem increasingly uneasy about keeping interest rates at negative levels still given Eurozone inflation has surged to record highs as the pandemic has receded.

March’s consumer price index (CPI) data resulted in headline inflation hitting 7.5% in the Eurozone as the first chart shows due to the energy shock from Russia’s invasion of Ukraine. But even core inflation, excluding energy and food costs, is running at 3.0% now in the single currency area.

Composite PMI, Eurozone & UK

Source: Bank of Singapore, Bloomberg.

Hawkish Bundesbank President Nagel said a first rate hike could happen ‘at the beginning of the third quarter’ while centrist ECB officials Kazakhs and Vice President de Guindos have also called for rate rises to start in Q3’22.

Second, the impact on Eurozone growth from the Ukraine war has so far been less than feared.

April’s purchasing manager indices (PMIs) shown in the second chart surprisingly rose to a seven-month high in the Eurozone. The composite index was a solid 55.8 this month, boosted by services PMI rising to 57.7 as Europe’s virus restrictions lift, though manufacturing PMI fell to 55.3 owing to the war in Ukraine, very high energy prices and lockdowns in China. Similarly, Germany’s IFO business confidence survey also rose this month.

The ECB may still delay its first interest rate hike if the situation worsens in Ukraine and European Union members ban Russian exports of gas. This would likely push the Eurozone into recession given how dependent several EU countries including Germany are on supplies from Russia. But a 25bps rise in the deposit rate from -0.50% seems likely now in July. The ECB may then keep increasing its deposit rate by 25bps every quarter until it reaches 1.00% in 2023.

ECB hikes should give support to the weak EUR though in the next three months, it is set to stay in a 1.05-1.10 range against the USD as the Federal Reserve considers 50bps hikes in May and June.

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Author:
Mansoor Mohi-uddin
Chief Economist
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