European Central Bank set to slow rate hikes as financial conditions tighten

FRANKFURT — The European Central Bank is expected to raise its benchmark rate by a smaller step of 25 basis points on Thursday, as core inflation eases and its own survey data points to much tighter financial conditions in the region.

The new economic figures both strengthen the case for the ECB to raise rates only a smaller amount at its policy meeting and possibly announce an acceleration in the pace of its balance sheet reduction. .

Quantitative tightening, or QT, has already happened, with the ECB shrinking its massive portfolio of bonds on its balance sheet after years of government debt purchases and monetary stimulus. The ECB has kept interest at zero and below for years and launched a bond buying program like the APP (Asset Purchase Program) and the PEPP (Pandemic Emergency Purchase Program) in an attempt to simulate lending .

The APP started in mid-2014 to deal with still low levels of inflation. It was frozen between January and October 2019, then lasted until July 2022 – but continued to reinvest payments from maturing assets. On the other hand, the PEPP was a more flexible bond purchase program introduced during the coronavirus pandemic.

“To prevent financial conditions from overreacting to a decline at a pace of +25bps, we expect the ECB to announce a faster QT: an increase in the APP reinvestment roll-off of 15 billion euros per month to 20 billion euros per month from the third quarter,” Deutsche Bank said. chief economist and ECB observer Mark Wall in a note to clients.

Eurozone inflation rose slightly to 7% in April, according to new data released this week, but core inflation – which excludes food, fuel, tobacco and alcohol – has slowed to 5.6% from 5.7%, its first drop since last June and lower than the market expected.

“The inflation trend is easing as the strong push in rising food prices fades,” Joerg Kraemer, chief economist at Commerzbank, said in a research note.

“It’s a positive sign that core inflation has fallen for the first time in a long time. But due to wage settlements above 5%, inflationary pressure is likely to remain stubbornly high.”

In addition, the ECB’s bank lending survey showed an exceptionally large drop in demand for credit amid tighter lending standards, which argues for a lower rate hike.

A net 38% of banks in the 20 countries that share the euro saw a drop in demand for business credit in the first three months of this year. This is the largest net decline since the global financial crisis of 2008-09.

While the Eurozone avoided a recession in the first quarter with anemic growth of 0.1%, the effects of the monetary tightening cycle are showing the first signs of a slowdown in demand. Traditionally, monetary policy has a lag of about a year and the ECB only started its hike cycle in June 2022.

“After May, we expect another 25 basis point rate hike in June,” Kraemer said.

“Afterwards, the ECB should stop raising rates and will monitor the effects of its tighter monetary policy on the real economy.”

— CNBC’s Silvia Amaro contributed to this article.