Monday, 2 October 2023

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Central banks head for peak rates — but inflation battle is not over

Pausing interest rate hikes now would be the right decision from the ECB, strategist says

Christine Lagarde, president of the European Central Bank (ECB), at a rates decision news conference in Frankfurt, Germany, on Thursday, Sept. 14, 2023. The ECB raised interest rates again, acting for the 10th consecutive time to choke inflation out of the euro zone’s increasingly feeble economy.

Bloomberg | Bloomberg | Getty Images

The central banks of some of the world’s biggest economies are now widely considered to have reached, or be at the brink of reaching, the highest level they will take interest rates.

The European Central Bank last week signaled that its Governing Council feels rates may have got there.

Following a long deliberation over its updated forecasts for inflation and economic growth and what they should mean for monetary policy, the ECB hiked its key rate to a record high of 4%. While its accompanying statement by no means ruled out further hikes completely, it said rates were at levels that if “maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.”

The short-term inflation outlook remains grim, and set to hit households hard. ECB staff macroeconomic projections for the euro area now see inflation averaging 5.6% this year, from a prior forecast of 5.4%, and 3.2% next year, from a previous forecast of 3%.

But the forecast for 2025, one of its most closely watched metrics measuring the medium-term outlook, was nudged down from 2.2% to 2.1%.

Discussion will now shift to how long rates will plateau at the current level, economists including Berenberg’s Holger Schmieding, said following the anouncement.

Analysts at Deutsche Bank said they saw no cuts before September 2024, implying a 12-month pause at 4%.

Challenges to this remain, however, with one being the prospect of significantly higher oil prices. Crude futures recently climbed to a 10-month high, which could impact goods costs and inflation expectations in Europe as well as the U.S.

Raphael Thuin, head of capital markets strategies at Tikehau Capital, said that despite consensus around the end of the ECB hiking cycle, “an alternative and less optimistic scenario remains possible: inflation is surprisingly strong and resilient, and appears to be structural.”

“Recent disinflationary factors (goods and commodity prices) seem to be running out of steam … There is a risk that, in the absence of a more convincing downward trend in prices, the ECB will consider its battle against inflation unfinished, with the risk of…

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