ECB review: A “no-brainer” hike and more to follow

The ECB hiked policy rates by 25bp at the September meeting, with the deposit rate at 2.50%, in line with consensus and market pricing.
The communication at the meeting, including the new projections, came as a very hawkish surprise to markets.
The ECB revealed a firm focus on energy prices in its reaction function, so we now expect the ECB to hike in both October and December.

Danske Research Team Danske Bank A/S

The ECB decided to hike its three key policy rates by 25bp at the September meeting, as expected, with the deposit rate at 2.50%. The ECB stated that “inflation is set to remain well above target for an extended period” in the press release, which was a clear hawkish surprise. Lagarde characterised the decision as a unanimous “no-brainer”, leaving the door wide open for further hikes. European rates rose across the board, led by the front end, with 2Y EUR swap rates rising around 15bp leading to a significant flattening of the curve. Markets price a total of 88bp worth of additional tightening with the peak reached in September 2027.

During the press conference Lagarde emphasised the surprisingly resilience of the economy. This has been due to new sources of growth such as global AI demand but also broad-based strength in Q2 which is expected to continue in the near term. On inflation, Lagarde mainly focused on energy prices and gave very few comments on developments in underlying inflation and wages. We see the benign developments of underlying inflation and wages as a dovish argument for the ECB, but the lack of focus on this in the ECB’s reaction function has been surprising to us. As the ECB reacts more to energy developments than underlying inflation compared to our previous expectations oftheir reaction function, we revise up our policy rate forecast.

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Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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