ECB Preview: Forecasts from 11 major banks, good moment to pause

ECB is widely set to be on hold in terms of policy rate changes for the first time since June last year. Since the September meeting, inflation and growth data have been broadly in line with expectations and taking into account the clear guidance from the ECB, no changes should be expected at the upcoming meeting. We expect Lagarde to acknowledge a discussion on advancing the PEPP reinvestments during the Q&A part of the press conference, thereby signalling a tightening bias, albeit with some optionality still in its communication.

We expect the ECB to keep rates on hold and to basically stick to a hawkish bias, keeping the door open to yet another rate hike in December.

Core inflation has improved significantly in recent months. Yet the ECB remains guarded given vagaries in the oil price and the possibility higher energy costs could cause a re-acceleration in headline inflation. We think the bar for another ECB rate hike is high. Outside of energy uncertainty, evidence from the monetary aggregates, real economic data and wage growth support an improvement in underlying inflation trends. Based on our assessment of the data, we think it is appropriate for the ECB to pause rate hikes. In addition, some leading hawks have suggested rates may now be appropriately restrictive.

After the ECB signalled at the September meeting that rates have likely peaked, while recent inflation data have actually surprised to the downside, the decision to leave rates unchanged at the 26 October meeting looks straightforward. We think the ECB is done for now, but note that if rates are changed further at the next few meetings, then rate hikes are more likely than rate cuts. For now, we estimate that rate cuts could start in June 2024.

The October decision should be a well-telegraphed hold, with the deposit rate remaining at 4.00%. We see a quite high bar for further hikes, and think the Governing Council will be more willing to tweak the length of time rates stay at terminal rather than resume rate hikes. The ECB is unlikely to be a major driver of EUR/USD. A mixture of peak US rates, weak USD and stable ex-US growth are needed to lift the EUR.

The ECB is unlikely to raise its key rates further, partly because the inflation rate fell significantly in September and was thus largely in line with the central bank's expectations. Looking ahead over the coming months, we can imagine that the central bankers will raise the minimum reserve rate from 1% to 2% in order to have to pay less interest to commercial banks.

We forecast the ECB will leave all of its key policy rates unchanged at its October meeting, so the depo rate will be unchanged at 4%. In our view, recent macro data by and large support the ECB as having finished its hiking cycle, even if it cannot declare victory on inflation just yet. We expect no announcement at the October meeting on accelerating quantitative tightening; however, this will likely be the focus of many questions at the press conference. While not our base case, a surprise could come in terms of minimum reserve requirements, government deposit remuneration, or excess reserve remuneration.

With the hiking cycle likely completed, it is up to the ECB to manage expectations of rate cuts. Inflation is continuing to trend in the right direction, but new risks have surfaced. The ECB should make it clear that they will not simply look through another energy shock, were this to materialize. We expect the ECB to leave its policy rates unchanged. We continue to see some risk of an increase in the minimum required reserves.

We expect rates to remain at 4.00%. We expect the ECB to repeat that keeping rates at their restrictive level for sufficiently long is how inflation will be brought back to target. This encompasses a guiding principle (the central role of duration) and optionality (what is meant by sufficiently long will be determined by the balance of power between hawks and doves).

With core inflation trending down and the economic outlook uncertain, the ECB should be on hold for now until greater visibility emerges over the outlook, which may not happen until March next year. We expect the ECB to accelerate QT once it has concluded the review of the operational framework in the spring of 2024.

With the Eurozone likely in recession and inflation heading lower, we also believe the ECB has reached peak policy rates. With that said, we expect the ECB will be cautious about reducing interest rates until inflation is much closer to its target. As a result, we do not expect an initial 25 bps rate cut until the June 2024 meeting, which would lower the Deposit Rate to 3.75%. Moreover, we expect the ECB to reduce rates at a gradual 25 bps per meeting pace through the second half of next year, which would see the Deposit Rate end 2024 at 2.75%. The combination of an underwhelming growth outlook and peak policy rates should also keep the Euro on the defensive around the 1.06 level for the time being.