European Central Bank to hike rates in June and July to break sticky inflation, economists say

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The European Central Bank will hike its key interest rates by 25 basis points on June 15 and again in July before pausing for the rest of the year as inflation remains sticky, according to a clear majority of economists polled by Reuters.

After a combined 375 basis points of hikes over the past year, economic activity in the 20-member bloc has slowed, with Europe’s biggest economic engine – Germany – and the euro zone as a whole falling into a winter recession.

Still, both economies are expected to rebound this quarter and the euro zone to grow 0.2 per cent in each quarter for the rest of the year, the poll showed. Price pressures and inflation expectations have moderated, but not by enough to deter the ECB from continuing its most aggressive tightening cycle on record.

ECB President Christine Lagarde said on Monday it was too early to call a peak in core inflation and reaffirmed rates would need to be increased again.

The central bank is forecast to raise its deposit rate again by a quarter percentage point on June 15 to 3.50 per cent, according to all 59 economists polled in the latest Reuters survey.

The ECB slowed the pace of its rate rises to 25 basis points at its May meeting after a flurry of 75 and 50 basis point moves.

About three-quarters of economists, 43 of 59, forecast another 25 basis point rate hike in July, a stance hardly changed from a May poll. That would take it to a terminal rate of 3.75 per cent, in line with market expectations.

“A 25 basis point rate hike looks like a done deal for next week’s meeting,” said Carsten Brzeski, global head of macro at ING.

“Macro developments since the May meeting have clearly had more to offer the doves than the hawks at the ECB... However, the ECB is fully determined right now to err on the side of higher rates.”

The U.S. Federal Reserve, by contrast, is predicted to remain on pause at its June meeting and for the rest of the year, according to a Reuters poll published on Wednesday.

But a significant minority saw at least one more rate hike from the Fed, more likely in July than June, which some say may give ECB policymakers further incentive to also raise rates in July to maintain the euro’s strength.

A weaker currency tends to put upward pressure on inflation through more expensive imports.

A majority, 38 of 59, then predicted the ECB’s deposit rate to remain unchanged at 3.75 per cent until the end of 2023. While 17 had it at 3.50 per cent or lower by year-end, four had it higher at 4.00 per cent.

The simple reason the ECB needs to do more is inflation has not come down enough.

Euro zone inflation was last reported at 6.1 per cent, still over three times the ECB’s 2 per cent target but down from a peak of 10.6 per cent in October last year. It is expected to remain above target at least until 2025, according to the poll, averaging 5.5 per cent and 2.5 per cent this year and next, respectively.

Core inflation, stripped of volatile food and energy components, slipped only to 5.3 per cent in May from a high of 5.7 per cent in March, and was expected to slightly moderate to average 4.9 per cent next quarter and 3.9 per cent in the final three months of the year.

“Core inflation is slowly peaking at a high level this summer and we are concerned that a tight labour market... and persistent wage inflation mean core is more likely to be above than at or below target,” wrote Mark Wall, chief Europe economist at Deutsche Bank.

“The ECB might not be convinced by the September meeting inflation is declining sufficiently to pause,” he said.