ECB hikes as staff projections keep December in play
The ECB has raised its deposit rate by 25bp to 2.50%, a move we have called for since July and one swaps had fully priced.
As in June, Middle East events are the driver, with the statement noting that the conflict continues to generate inflation pressures. That backdrop has only deteriorated since the projection cut-off. Tit-for-tat strikes between US and Iranian forces around the Strait of Hormuz pushed Brent back through $100 per barrel earlier in the week, while European gas prices sit at their highest since 2022. A modest hawkish tilt to the Bank’s updated guidance, and President Lagarde’s comments in light of this, are offering modest support to the euro in the face of a broad dollar rally this afternoon.
Looking first at the ECB’s updated staff forecasts, core inflation is now seen at 2.6% in 2027 and 2.3% in 2028, up from 2.5% and 2.2% in June, with headline lifted to 2.5% and 2.1% respectively.
Growth was also revised higher to 0.9% this year and 1.4% next, citing greater-than-expected resilience. That is a hawkish set of numbers relative to our expectations, which had anticipated a more stagflationary outlook. Such views were instead relegated to the Bank’s characterisation of the balance of risks, though given the forecast cut-off occurred before the latest leg higher in energy costs, it was unsurprising to hear President Lagarde’s press conference assessment tilt slightly in this direction.
All in all, today’s guidance keeps further tightening in play over the coming months.
Lagarde, as usual, refused to be drawn on the prospect of such moves in her comments, citing the uncertain outlook. We do not, however, share the market view of three additional rate increases in the coming year, as is now priced into swaps. Labour market conditions are not obviously adding to inflation pressures as they following Russia’s invasion of Ukraine, wage growth remains modest and contained, and passthrough from elevated energy costs to other CPI components appears limited, for now at least, all points referenced either explicitly or implicitly in the press conference.
With policy now at 2.50%, the upper end of the ECB's neutral range, our expectation is now for greater caution when it comes to future tightening.
A December policy rate increase remains on the table, with the evolution of energy costs over the coming months likely to be the deciding factor. But we also see a high bar for the ECB to deliver the total magnitude of tightening now anticipated by traders, limiting the extent to which the euro can gain on rising policy rate expectations. That balancing act leaves us with a modest upside EURUSD bias, with tomorrow's US CPI and Gulf headlines as the dominant near-term drivers.