The ECB's Governing Council said today (14 September) that the central bank now forecasts average inflation will reach 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025, with the upward revisions being credited largely to a higher path for energy prices.
However, ECB projections for core inflation were revised slightly downwards to an average of 5.1% in 2023, 2.9% in 2024 and 2.2% in 2025.
The central bank said that previous hikes continued to be "transmitted forcefully" into the economy, as financing conditions tighten and demand increasingly dampens.
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"With the increasing impact of this tightening on domestic demand and the weakening international trade environment, ECB staff have lowered their economic growth projections significantly," it said.
It is now expected that the euro area economy will expand by 0.7% in 2023, 1% in 2024 and 1.5% in 2025.
Based on this, the council indicated this was likely to be the final hike of the cycle, stating it believed rates had "reached levels that, when maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target".
Mike Bell, global liquidity market strategist at JP Morgan Asset Management, agreed with the assessment, noting the ECB was "probably done hiking" due to indications from business surveys that growth was facing an imminent slowdown.
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"The new orders component of the latest business surveys were very weak. Incoming new business for the service sector is contracting now, joining new orders for the manufacturing sector in the doldrums," he said.
Therefore, Bell predicted that the ECB would likely pause, leaving room to either cut rates if growth continued to slow and unemployment rises, else leave rates "on hold for quite some time".
Before the meeting, markets had priced in a 68% chance that the ECB would hike rates, according to data from Bloomberg.
Neil Birrell, CIO at Premier Miton Investors, said that the move "was probably a relatively easy decision" for the ECB, given the rising inflation forecasts.
"However, they also need to prevent any optimism on rates coming down any time soon, as they project core inflation at 2.2% in 2025 and have unsurprisingly cut growth forecasts at the same time," he added.
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Richard Carter, head of fixed interest research at Quilter Cheviot, said that the ECB had decided 4% is "the level it feels comfortable with, allowing interest rates to climb to and help bring inflation down", but argued it still saw the need to consider one more hike before taking an extended pause.
Carter warned the ECB was now facing "a similar bind to the Bank of England", with faltering growth risking that another hike could "tip the balance and bring along a prolonged period of economic stagnation".
"Expectations that the Federal Reserve would pause and the rest would follow may need to be put on hold for now. This new era of diverging monetary policy has a while to last yet," he concluded.