ECB to lower rate hikes

On Thursday, the European Central Bank (ECB) is expected to raise its benchmark rate by only 25 basis points due to declining core inflation and tighter financial conditions within the eurozone. ECB’s quantitative tightening (QT) has already been in progress, and now the ECB is looking to possibly announce an increase in the pace of its balance sheet reduction. This will involve the acceleration of the APP reinvestments’ roll-off from €15bn to €20bn per month from Q3.

The Asset Purchase Program (APP), introduced in 2014 to tackle persistently low inflation levels, was frozen between January and October 2019 but lasted until July 2022, with the ECB reinvesting payments from matured assets. In contrast, the Pandemic Emergency Purchase Program (PEPP) was a more flexible bond purchase program launched during the coronavirus pandemic. The ECB has maintained interest rates at zero, and below, for years and has implemented bond-buying programs to stimulate lending.

According to recent data, inflation in the eurozone slightly rose to 7% in April, but core inflation, which excludes food, fuel, tobacco, and alcohol, decreased to 5.6%, its first decline since last June and lower than market expectations. The ECB’s bank lending survey also indicates a significant drop in credit demand, adding to the case for a smaller rate hike, with a net 38% of banks in the 20 nations sharing the euro experiencing a decline in credit demand from companies in Q1 of 2023, the biggest decline since the global financial crisis of 2008-09.

Although the eurozone avoided a recession in Q1 of 2023 with anemic growth of 0.1%, the effects of the monetary tightening cycle show the first signs of dampening demand. Monetary policy typically has a lag of around a year, and the ECB began its hiking cycle only in June 2022. Following the expected rate hike in June 2023, the ECB should finish hiking rates and observe the impact of its tighter monetary policy on the real economy.