The ECB is highly expected to follow in the footsteps of the FOMC and implement another 25bps rate hike, which would bring the Refi rate to 4.5% and the Deposit rate to 3.75%. However, what happens afterwards will undoubtedly hold the greatest significance.
The upcoming ECB meeting is anticipated to align with President Lagarde’s previous statement, pointing towards a 25bp rate hike. As Lagarde indicated, unless there’s a significant shift in the macro backdrop, the increase is very likely to proceed as expected. Given that the macro conditions haven’t experienced substantial changes, surprises are not expected in this regard.
Source: JPM Markets
As we approach the current meeting, the 25bps rate increase appears to be a certainty. Looking ahead, there’s a strong indication that another 25bps hike is in the pipeline for the following quarter, and little else in terms of rate adjustments, except for potential rate cuts in 2024.
The market’s expectation of rate cuts in 2024 is not insignificant, and the reason behind this anticipation is worth considering. Is it driven by an immaculate disinflationary environment resulting from a prolonged period of growth stagnation? In the case of Europe, it seems that the latter scenario is the most likely outcome as the growth perspective seems bleak.
ECB Balance Sheet
It’s unlikely that there will be any discussion about accelerating Quantitative Tightening (QT). Most probably, this aspect will remain unchanged. Any potential adjustments here could be perceived as highly hawkish, exerting pressure on peripheral spreads in the market.
Regarding the Targeted Long-Term Refinancing Operations (TLTROs), it is not expected that there will be discussions about new liquidity measures to ease repayments. The TLTRO repayments have been progressing smoothly so far, which should avoid the need for further interventions in this area.
Macro Regime Outlook
Growth seems to remain weak. The chart below on manufacturing PMI in Germany sends a clear message.
On a broader scale, the economic surprise divergence between the Eurozone and the US is growing, indicating a notably more resilient economy in the US.
The disinflation trend appears to be present in both the US and Europe, though at varying levels. In Europe, inflation is showing signs of plateauing at higher levels, potentially presenting a challenging situation for the ECB to address.
The most probable outcome points towards a 25bps rate increase and a general commitment to further hikes in Q4, with a likelihood of around 65%.
There are two alternative scenarios on the table. One suggests a more hawkish approach from the ECB, with a pre-commitment to further hikes in September, possibly accompanied by discussions about accelerating Quantitative Tightening (QT). I assign a probability of 15% to this scenario.
The other alternative envisions a more dovish stance from the ECB, with Lagarde acknowledging the significant slowdown in the eurozone economy. This scenario is given a probability of 20%.
In my view, the Eurozone is currently experiencing a more Stagflationary environment compared to the US. Typically, we’re accustomed to similar inflationary patterns globally, but this time around, things might be different. The US economic model not only generates more growth than the Eurozone but also exhibits lower inflation.
This situation is likely to make the road ahead much more complex for the ECB than for the Fed. The challenges and uncertainties they face will be significant, and it’s going to be an intriguing journey to see how they navigate these waters. The stakes are high, and the bets are on !
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