European Central Bank: Dovish hold may follow September hike - Rabobank

Rabobank's Senior Macro Strategist Bas van Geffen expects the European Central Bank (ECB) to hike its deposit rate by 25bp to 2.50% next week and then hold at that level for an extended period. They note markets are pricing a more adverse path with a 3.00% terminal rate, while stressing upside risks if inflation broadens and growth stays resilient.

Markets see higher terminal rate risk

"The ECB will almost certainly hike rates next week, and the markets’ focus is on the path for policy rates after September. We maintain that policymakers will probably hold rates at 2.50% for an extended period, but risks are skewed to further hikes. Those hikes will only materialise if price pressures spreads beyond energy inflation and the economy remains resilient."

"The recent increase in energy prices cements the case for another rate hike when the ECB meets next week. The ECB will remain vigilant, but we expect a more restrained tone for the road ahead than current market pricing."

"So, President Lagarde will reaffirm that the ECB stands ready to act again if this is necessary, but she has little to gain from any stronger pre-commitment. We believe that the market could construe her attempts to keep all options open as somewhat dovish. The ECB would probably not mind that, given current market pricing."

"Current money market pricing is consistent with an ECB that maintains its “measured pace” of tightening, but in a scenario where policymakers are forced to take policy rates into restrictive territory. The OIS curve embeds 85% probability that the ECB will have to hike once more before the end of the year, with a 15-20% tail risk that the ECB may need to accelerate the pace of hikes in October. Furthermore, traders currently price a terminal rate of around 3%."

"Having said that, risks are firmly to the upside. In June, the ECB has proven that it has limited tolerance for inflation risk. If inflation expectations are at risk of accelerating or if there are signs that inflation is starting to spread beyond the direct and indirect effects of higher energy prices, the ECB will not hesitate to hike again."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)