The last event, the Jackson Hole economic symposium, showed that the Federal Reserve (Fed) and other major central banks remained focused on their core mandate, to achieve low and stable inflation around 2%, despite rising unemployment and the risk of recession (Will the eurozone enter recession in the second half?). As the next ECB meeting approaches, we wonder whether the European monetary authority will continue with a controlled interest rate hike or show signs of tightening.
The latest eurozone HICP inflation figures surprised on the upside, coming in at 9.1% in August, up from 8.9% in July, and setting a new record since the creation of the euro. On the other side of the balance, however, is the risk of a harsh winter and an increasingly plausible near-collapse into technical recession. We asked professionals about their forecasts for this new meeting of the institution chaired by Christine Lagarde.
Konstantin Veit, Portfolio Manager at PIMCO
After having hiked interest rates back to 0% at its July monetary policy meeting, we believe the ECB will hike policy rates another 50 basis points at its September meeting and communicate that further increases in interest rates will be appropriate. We believe the Governing Council (GC) will aim to bring its policy rates into neutral territory reasonably quickly, and expect additional 50 basis point policy rate hikes in October and December as a result.
We think the GC will make clear that a neutral policy setting might not be appropriate in all conditions, and expect a transition towards moving in 25 basis point increments next year as the hiking cycle pivots from policy normalisation to policy tightening. The ECB seems determined to put the fight against inflation ahead of growth concerns, the macroeconomic configuration remains complex and political risks elevated.
Gilles Moëc, Chief Economist at AXA IM
Eurosystem representatives speaking in Jackson Hole came with some stern warnings, even if ECB-speech still come in different flavours. Isabel Schnabel has for some time appeared as the most eloquent spokesperson of the hawkish persuasion at the ECB board, and she stuck to this line; one of her main points was that once there is a tangible risk inflation becomes persistent, it becomes irrelevant whether the source of the acceleration in consumer prices stems from an economy that is overheating; Inflation expectations need to be tamed, and this requires “robust action” from the central bank – even more robust than in the past; in terms of message to the market, things are clear: yes, the ECB is facing lots of uncertainty as macroeconomic volatility has risen, and yes, a recession may be looming, but the direction of travel for monetary policy is towards more tightening.
Banque de France Governor, Villeroy de Galhau’s speech caught observers’ attention with his direct warning: “have no doubt that we at the ECB would if needed raise rates further beyond normalization”. Yet, he also stuck to the “non-linearity” in the policy discussion he has been supporting for several months: until the neutral range is hit – between 1% and 2% – for the policy rate, the tightening pace can be sustained without much debate. Going for restriction would however take another thorough discussion at the Council. Yet, these differences probably matter for 2023 only. For now, hawks and doves can be united on bringing policy rates at least into neutral territory. This would suggest that beyond another 50 basis points hike in September, the “natural slope” would be a continuation of the tightening towards 1.25% by year-end.
Dilllon Lancaster, Portfolio Analyst at TwentyFour Asset Management
Last week, Fed Chairman, Jerome Powell, used its flagship Jackson Hole event to send a clear message to the markets: there will be “restrictive policy stance for some time”. This, Powell argued, is a necessity to regain a grip on inflation even if it may inflict “some pain to households and businesses”. The notion that the Fed were not getting carried away with August’s encouraging inflation release had already been signalled by other FOMC members, we believe prudently, prior to Jackson Hole, so it probably shouldn’t have come as a huge surprise. Nonetheless, this confirmation, from the consensus voice of the Chair, that the job was not yet done on inflation led to an increase of the market’s implied terminal Fed Funds rate and risk assets selling off, with the S&P dropping more than 3% on Friday. Non-voting Fed member, Neel Kashkari, followed this up by saying “I was actually happy to see how Chair Powell’s Jackson Hole speech was received,” and that “people now understand the seriousness of our commitment to getting inflation back down to 2%”.
Powell, was less revealing, however, on the size of hike markets should expect in the upcoming September meeting. Indeed, next month looks set to be a very important period for central bank meetings, with rate decisions from the Fed, ECB and BoE all in the space of two weeks. As we speak, the markets are evenly split between whether we see 50 or 75bp hikes from each of the central banks and decisions could be dependent on the data leading up to it. With important releases such as CPI, ISM surveys, employment and PPI data across their respective geographies all on the way, we think these will probably determine what magnitude of hike we get from Powell, Lagarde and Bailey.
However, as is often the case, the rhetoric surrounding the hikes could be much more important. From the ECB, we have updated economic forecasts which will now surely include more realistic higher energy prices baked in for the foreseeable future. While the Bank of England should have more clarity over a new UK Government as the Conservative leadership election draws to a close and must attempt to cement greater credibility with the markets in the face of increasing UK inflation predictions. In particular, for Lagarde and Bailey we see this as a chance to underline their commitment to inflation and set out their outlook for the rest of 2022 and next year, just as Powell did at Jackson Hole. And even though we’ve just heard from the Fed, and hear from FOMC members frequently, the latest release of the Fed’s Dot Plots will be very interesting, particularly whether the FOMC members’ predicted terminal rate has actually increased, or whether Powell’s recent comments were just reaffirming a commitment to the pre-existing forecasts.
Andrew Bailey said earlier on this year that in the world of central banks, there is always another meeting – however, currently each meeting seems to have the seismic importance of a Jackson Hole event!
Gergely Majoros, a member of the Investment Committee at Carmignac
The situation the ECB is facing has become highly delicate. It must address inflation in an environment where there is a high risk of recession in the Eurozone, and at the same time, the risk of market dislocation or at least, further weakening of the euro.
Given the recent indications of a broadening of inflation data beyond energy price pressures and the impressive weakening of the euro, which is itself inflationary, we believe the likelihood of a rate hike of 0.75% for the coming ECB meeting has risen significantly.
The main question at this stage, however, is whether the ECB will indicate a change of strategy for the remaining meetings this year.
While the market is almost pricing a 75 basis points rise for this week, the expectations for October and December are significantly lower than 75 basis points. But, with the ECB keen to close the gap to neutral as quickly as possible, we believe there is a high likelihood of an acceleration of interest rate hikes to 75 basis points each time. Indeed, rate hikes could be much more difficult to deliver in 2023, due to the potentially recessionary environment, moving past peak inflation and the US Fed pausing its hiking cycle. The recent Gazprom announcement that it’s cutting the gas supply to Europe further supports this view.
In this scenario, not only is peak inflation in the Eurozone approaching quickly, expected for the fourth quarter of 2022 but peak hawkishness of the ECB as well. Indeed, we expect the quasi-gas embargo and droughts to add to the sustained pressure on prices for energy and food in the coming months. But the level and the exact timing of the peak are still dependent on how governments will deal with the passthrough of energy price increases to the end customers.
For the time being, for investors, we believe that prudence should remain the name of the game in both fixed income and equity markets. Visibility remains low. Investors looking for inflection points in markets should however remain alert over the coming months. The moment for central banks like the ECB to capitulate on their aggressive tightening will come, even though we are not there yet.
Axel Botte, Global Strategist at Ostrum AM
The ECB is likely to raise rates by 75 bp (refinancing rate up to 1.25%, deposit rate at 0.75%) in an unprecedented move. Inflation above 9% is the chief concern for policymakers. The weakness in the euro and high energy import costs also argue for higher short-term rates. Persistent inflation would lead to more rate hikes in 2023.
In July, the announcement of the TPI aimed at mitigating financial stability risks provides some leeway for the ECB to raise rates faster. After 75 bp, the ECB may raise rates again by 50 bp twice in October and December.
The ECB will revise its forecasts for inflation (likely way up in our view) and growth (moderately down for 2023). The 2.1% forecasts for 2024 inflation is most at risk.
One issue for the ECB is to deal with collateral scarcity and blown-out swap spreads. Governments, banks, and other financial entities have surplus cash to lend in repo markets. The ECB could decide to raise the remuneration on reserves at the ECB (mostly linked to refi) or lend out a larger share of the bond portfolio it has accumulated with the various quantitative easing programmes. In essence, excess liquidity remains too large to ensure that market-determined interest rates rise alongside ECB policy rates. However, it could take long discussions and several meetiongs before policymakers agree on the best way forward regarding the collateral scarcity issue.
Adrian Daniel, Fund Manager at de Mainfirst
The renewed widening of the risk spreads of the EU periphery on Friday in reaction to the discussion about a 75bps interest rate hike shows how problematic the position of the ECB is. Attempting to combat the inflation problem only increases the challenge for the ECB in its aim of preventing the fragmentation of the EU.Even with a rate hike of 75bps in September, the ECB would still not achieve any credibility in its goal of combating inflation. This requires a solution to the so-called fragmentation of the eurozone.
The massive price increases in the European gas and electricity markets in recent weeks will be followed by further negative surprises, especially in producer prices. Therefore, from the markets’ perspective, inflation concerns are unlikely to be resolved even in the event of a 75bps hike by the ECB. On the other hand, concerns about a recession are likely to be confirmed.
In light of the current market situation, we are very cautiously allocated in the multi asset strategy both in terms of net equity exposure (currently 12% with a possible 0-50%) and duration (below 3) compared to historical standards.