“Even higher for an even longer period of time” markets are increasingly pricing European Central Bank interest rates, especially after new data on inflation in the Eurozone.

The level of the final ECB interest rate is one part of the equation, but how long it will be held at these levels is what the markets are watching with the most nervousness. Since the effects of higher interest rates are significant and not yet fully felt in the economy, since it takes 9-12 months to see real “damage” from monetary tightening, the length of time they will be maintained on high level, is also the most important factor to buy.

However, for now, all the new data justifies the continued aggressiveness of the ECB, and inflation is testing its resilience. The data for February was a wake-up call. After three successive inflation surprises in the previous three months, and with natural gas prices dropping below €50/MWh by an impressive 65% since the start of December, things looked poised for another significant fall in inflation. But that did not happen. And while headline inflation fell just 0.1%, core inflation took center stage – after all, that’s what the ECB “looks” at when making policy decisions—as it surged to a record high of 5.6% in on an annualized basis. year.

Although the ECB began tightening monetary policy much later than other major central banks, it could eventually overtake the Fed in aggressiveness.

“The ECB will be increasingly uncomfortable with postponing inflation normalization, so we see an increased chance for more hawkish board dynamics,” said Antoine Gaveau, an analyst at Citigroup.

Although the ECB entered the monetary tightening dance much later than the other major central banks, it appears to have no choice but to keep raising interest rates to combat spillovers from rising energy prices. “The ECB will become increasingly hawkish given stronger growth and more robust inflation, and while it hasn’t fallen behind yet, it could eventually overtake the Fed in aggression,” Goldman Sachs said.

To some extent, discussions at the February meeting of the ECB, as the minutes published last week showed, seemed quite prophetic, said Fabio Balboni, chief economist at HSBC. As noted, “the squeeze in risk premiums was based on a strong market belief that inflation is on a sharp and sustained downward path to 2%,” while the Board estimated that “a stronger continuation of underlying price pressures could to a reassessment of the prospects for monetary policy and correction of asset prices”.

That is exactly what has happened in recent weeks, Balboni notes, in the form of stronger inflation data in the eurozone as well as the US and aggressive comments from board members. The ECB led the market to significantly change interest rate expectations.

Under 4% until September

The ECB already announced its intention to continue raising another 50 basis points at its March 16 meeting, bringing the deposit rate up to 3%. According to analysts, this is considered a “dead matter”. It is now “given” that there will be a further increase by the same amount in May, with further tightening in June and probably also in July.

According to French central bank governor Villeroy de Gallo, the ECB will seek to stop price increases by changing the path of core inflation, except for energy prices. In his opinion, it is desirable that the final interest rate be set in the summer or at the latest by September.

Investors, for their part, expect the ECB’s deposit rate to reach 4%, up from the 3.5% they previously expected, and at a historically high level. This means that the ECB’s tightening cycle, already the fastest and longest in its history, will end with an overall gain of around 450 basis points. Moreover, Belgian central banker Pierre Vaughans did not rule out that the final interest rate could reach 4% if inflation continued.

International investment banks have also changed their final interest rate forecasts: Morgan Stanley, Bank of America, Danske Bank and Barclays now estimate it at 4%. As Barclays analysts Silvia Ardaniya and Mariano Sena said, the surprise on the structural inflation front will lead the ECB to say that the inflation outlook justifies extending the period of “significant growth” after March. Thus, Barclays estimates that interest rates will also rise by 50 basis points in May, with a new increase of 25 basis points. to follow in June and the final on 25 m.v. in July. Similar forecasts for the course of interest rates are given by Morgan Stanley, Bank of America.

UBS raised its forecast to 3.75% from 3.25% earlier, stressing, however, that it does not rule out that the final interest rate will reach 4%. As he explains, he now sees an increase of 50 b.v. and in May (from 25 b.p. earlier), while adding a 25 b.p. in June. “We cannot rule out a move to 50 m.p. and June or a final rate hike in July if the overall inflationary environment does not improve quickly enough,” he notes.

And Goldman Sachs now expects a fourth 50 basis point rate hike in May from 25 basis points. previously expected, with the ECB’s final interest rate set at 3.75% by June (versus 3.5% previously).

Pressure on the European economy until 2024

The eurozone economy has shown resilience so far, likely avoiding a recession expected this winter, another factor confirming the aggressiveness of the ECB. Analysts say this is partly because the full impact of the monetary tightening that began in July 2022 remains to be seen. Theoretically, as they note, it will take 9-12 months to feel good.

How long such tight monetary policy is maintained is also critical to the growth path, as pressures will continue to affect the economy even after the ECB’s “stance”. As Moody’s emphasizes, the decisions of central banks on how much to raise interest rates, for how long and when they begin to decline, will be the main “drivers” of economic growth in 2023 and 2024.

Since the tightening will continue until at least the summer, this means that the impact on the economy will not only affect this year, but also next year. “Consequently, the economy will slow down in the second half of the year, and growth in 2024 is likely to be weaker than in 2023,” warns ING. There is no doubt that the tightening of the ECB’s monetary policy will ultimately dampen growth. According to ECB models, the negative impact of the current monetary tightening on real GDP growth is estimated at an average of 1.5% per year over the three years from 2022 to 2024, with the largest impact in 2023 and 2024.

Goldman Sachs and ING estimate that the ECB will keep its final interest rate until the fourth quarter of 2024. It won’t cut rates until March 2024, according to UBS, while Société Générale predicts the first rate cut in the second half of 2024. .

For the ECB to consider cutting interest rates, the key criterion for Villeroy de Gallo, he stressed, is “a return to an inflation outlook consistent with the 2% target, strong and sustainable.” “Strong”, according to Société analysts, means that it will be supported by real data on inflation, both general and structural. ‘Sustainable’ means ahead of the ECB’s forecast horizon (i.e. less than two years), including lowering household and business inflation expectations to 2%.

Christine Lagarde

The ECB may have to continue raising interest rates beyond the planned 50 bps increase. Christine Lagarde said at the March meeting. “Now we will probably continue on this path,” he said, adding that the pace of future growth will be determined by the economic data available at that time.

by 4% the market places the ECB’s final interest rate, with a total increase of 450bp.

Joachim Nagel

“The March rate hike will not be the last,” Bundesbank President Joachim Nagel said, adding that “further significant rate hikes may be needed in the future.” At the same time, he argued that the final interest rate should be maintained long enough to meet the inflation target.

1.5% per year in 2022-2024, it is supposed to subtract the current tightening of the ECB from the growth of the real GDP of the Eurozone.

Pierre Fon

“The ECB may consider raising interest rates to 4% if core inflation in the euro area remains persistently high,” said the head of the Belgian central bank and board member. ECB, Pierre Fon. “If we do not see clear signs that structural inflation is declining, we will have to do more,” he stressed.