ECB preview: Lagarde to bring September into play – We revise our ECB call

We revise our ECB call slightly after the recent Governing Council (GC) comments, hawkish minutes and inflation surprises. We now look for a 25bp rate hike in both September and December 2022. Beyond that, we do not look for a prolonged hiking cycle into 2023 at the current stage as inflation falls back to target and Fed tightening will also have contributed to a significant tightening of financing conditions globally – thereby worsening the economic outlook.

Yet another challenging meeting awaits next week, with ECB facing an increasingly uncertain economic outlook. The economic backdrop since the last meeting has moved further towards a stagflationary scenario in the euro area, with weakening growth, higher uncertainty, lower confidence and higher inflation. However, the increasing risk of unanchored inflation expectations and second round effects on wages will keep the pressure on ECB to proceed with its policy normalisation despite rising recession risks in our view.

While we expect the statement to re-confirm the decisions taken at the March meeting just 4 weeks ago, with its guidance to end APP during Q3 and the first hike to come ‘some time’ after the end of net asset purchases, we believe the press conference will be the most interesting part, where we expect Lagarde to repeat the gradual, flexibility and optionality mantra. While we do not expect Lagarde to directly mention a September rate hike as a possibility, similar to other voices in the GC, we believe she will keep the door open as a way to respond to high inflation pressures.

We expect markets to buy in to September hike in play (current 31bp priced for September) and thereby we also believe that risks are skewed towards a hawkish market reaction, notably in the 2022 segment of the curve, where there are currently 66bp priced (€STR terms).

Caught in the stagflation trap

The first euro area data releases after Russia's invasion of Ukraine made for an ugly reading, with consumer and business confidence falling back to levels last seen during the early days of the pandemic (see also Euro Area Macro Monitor - Caught in the stagflation trap, 5 April). While government support measures (estimated to amount to 0.4% of GDP by ECB), will probably cushion the economic fallout, the loss in purchasing power already amounted to 3.5% of euro area GDP at the end of 2021. Since households cannot easily reduce their consumption of food and energy in response to rising prices, a marked slowdown in private consumption growth likely lies ahead. The manufacturing sector is also faced with increasing supply disruptions and a possible Russian energy embargo idling production, increasing the risk of a recession as already indicated by our growth tracker.

At the same time, inflation pressures continue to build at an unrelenting pace. HICP and core inflation rose to new record highs of 7.5% and 3.0% during March and with cost-push inflation still working its way through pricing chains, we doubt that we have seen the inflation peak yet.

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