The ECB is preparing for a decisive turn towards a restrictive monetary policy, at the next meeting on 11 June, interrupting the process of downward adjustment of the cost of money, due to the energy crisis. After a period in which the markets expected cuts, the recent oil shock caused by the conflict in the Middle East (Iran) has reversed the scenario, pushing central banks towards a faster than expected “normalisation” of rates.
But what are the opinions and expectations of analysts regarding the next meeting of the Frankfurt Institute? At the moment, the market is pricing in a 25 basis point increase in key rates with an almost complete probability of 97%.
The dilemma between persistent inflation and declining growth
The ECB’s task is made difficult by a “divergence” of macroeconomic parameters: on the one hand, growth estimates for the Eurozone have been revised downwards due to geopolitical tensions; on the other hand, inflation forecasts are increasing. In May, headline inflation rose to 3.2%, while core inflation stood at 2.5%.
Experts point out that, unlike the post-Covid period characterized by excess demand, the current pressure on prices derives from a shock on the energy supply side, which reduces the room for maneuver in the face of a sustained inflationary spiral, but still requires intervention to anchor expectations.
Guidance and future prospects: Lagarde’s tone
In addition to the immediate decision in June, investors’ attention is focused on guidance for the second half of the year. Some ECB officials have already taken a “hawkish” tone, in particular the German economist Isabel Schnabel, known for her restrictive position within the Board, who suggested that rates could reach 4% by the end of the year.
Despite this, analysts predict that President Christine Lagarde will maintain a cautiously restrictive approach, trying to balance the fight against inflation with the significant slowdown in European economic activity. The main objective of the June hike, which is therefore preventive in nature, would be to preserve the credibility of the central bank, while keeping the door open to further tightening if the conflict in Iran were to persist.
Impact on financial markets and the euro
The repricing of rates has already had an effect on the bond market. Short-term yields have become decidedly more attractive: Johnathan Owen, portfolio manager at TwentyFour Asset Management (Vontobel) reports that “all-in” levels on the 1-5 year Investment Grade index in Europe reached 3.39% at the beginning of June.
As regards the foreign exchange market, UBP analysts are skeptical about a possible strengthening of the single currency; Historically, ECB rate hikes during supply-side shocks rarely lead to euro appreciation, especially in an environment of anemic growth relative to the United States.
The issue of public debt and the PNRR
A further element of concern for the ECB and European governments is the management of public debt. The European Commission’s new forecasts indicate an increase in debt, – underlines Alessandro Tentori, Chief Investment Officer Europe AXA IM Core, BNPP AM – with Italy possibly reaching 139.2% in 2027, making an excessive debt procedure likely in 2025.
In this scenario – explains the analyst – the impact of the PNRR on potential GDP growth seems to have been overestimated by governments; according to some studies, the recovery objective would have been only half achieved, leaving Europe at a competitive disadvantage compared to the USA
