ECB Preview: Forecasts from 10 major banks, a hike or a hawkish pause?

While a hike and a hold are almost equally likely, we now expect the ECB to keep the deposit rate unchanged at 3.75% at the September meeting. We also think this will mark the end of the tightening cycle, though risks still remain around an October hike. We're neutral EURUSD heading into the ECB, highlighting the mix of stretched USD positioning and short-term valuations and a softer China backdrop.

We expect the weakening data to allow the ECB to stay on hold to assess more data. However, we do not expect the ECB to give up on its hawkish bias before it is fully clear that the 2% target can be achieved in a timely fashion, and expect one more rate hike this year, likely in December, and more QT early next year. 

With the rate decision at the 14 September ECB meeting finely balanced, the ECB staff projections will play a key role. The projections will be coordinated by ECB staff, as opposed to national central banks. In recent exercises, that has tended to produce more dovish results at least on the 2024 core inflation forecasts. We expect ECB staff to cut the euro area GDP projections substantially from 0.9% in 2023, 1.5% in 2024 and 1.6% in 2025 to 0.5% in 2023, 0.7% in 2024 and 1.4% in 2025. That should also set the unemployment rate on a modestly rising path. However, we expect higher inflation forecasts for 2023 (5.7% vs. 5.4%), broadly unchanged in 2024 at 3.0% and slightly lower in 2025 (2.1% headline and 2.2% for core).

We admit that it is a very close call, but still too high inflation, a focus on actual rather than on predicted developments, and the fear of stopping prematurely will tilt the balance towards a final 25 bps rate hike.

We expect policymakers to hold rates steady at 3.75%. At the same time, policymakers may give themselves flexibility to raise rates at future meetings depending on how data evolve, especially core and super-core inflation. This mildly hawkish bias should also prevent ECB policymakers from easing monetary policy too soon. To that point, we recently adjusted our ECB forecast profile to reflect a ‘higher for longer’ stance. Rate cuts are likely to start in mid-2024, and when they begin, we expect a more gradual pace of easing than previous iterations of our ECB forecasts.

Our economists have nervously held their 3.75% terminal deposit rate call for many months now, and as such they think the ECB will stay on hold. However, even if they don't hike this week, don't expect any sign that the council is confident that this is the last hike. A lot of uncertainty remains over European inflation, whilst GDP has been in near-stagnation since last autumn.

We expect the ECB to deliver a final 25 bps rate hike due to still too strong inflation momentum and projected inflation above the target. We also expect an advancement of the end to full reinvestment process of PEPP currently guided for Dec 24 to be on the cards. Specifically, we expect ECB to 'task committees' for an announcement at the October meeting. 

Thursday’s decision will be a close call. We narrowly favour a hold, and we expect the ECB to maintain that more hikes may still follow. The growth outlook is deteriorating, and overtightening is becoming a real possibility. But inflation remains high, and thus the odds of another hike are more than just a tail risk. We expect the ECB to leave its policy rates unchanged. We see a small risk of an increase in the minimum required reserves at this meeting.

In view of the weak economy and the downward trend in the inflation rate, the ECB is unlikely to raise its key interest rates further, and interest rates are also likely to remain unchanged at subsequent meetings. the same applies to the coming year, as underlying inflation is likely to prove stubborn, especially in the services sector. Other topics could be the end of the PEPP pandemic purchase programme and the remuneration of excess liquidity, although there are unlikely to be any decisions on these.

The ECB is torn between whether to hike rates again or not. We think the Governing Council will pause, but signal preparedness to do more at upcoming meetings, if needed. Both inflation and growth forecasts could see downward revisions.