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Euro zone inflation 8.6% in June, ECB to hike rates for first time in 11 years

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The ECB has announced it will be hiking rates in July and September to counter record inflation.

Daniel Roland | Afp | Getty Images

Euro zone inflation reached a new record high in June just ahead of the European Central Bank’s first rate increase in 11 years.

Headline inflation came in at 8.6% (year-on-year) for last month, according to preliminary figures from Europe’s statistics office Eurostat released Friday. That beat a prediction of 8.4% in a Reuters poll of economists. The rate had reached 8.1% in May which means the cost of living is continuing to surge across the euro zone nations.

Germany surprised many earlier this week when it reported a drop of 0.5 percentage points in inflation month-on-month. Experts said this was due to new government subsidies to ease the impact of higher energy prices and it was not yet the end of surging inflation rates.

But both France and Spain experienced new inflation records in June with the latter surpassing the 10% threshold for the first time since 1985, according to Reuters.

ECB action

The ECB, which has vowed to tackle the surge in prices, is due to meet in late July to announce it’s increasing rates. The central bank has said it will hike again in September, meaning its main interest rate could return to positive territory this year — the ECB has had negative rates since 2014.

Speaking earlier this week, ECB President Christine Lagarde struck a hawkish tone.

“If the inflation outlook does not improve, we will have sufficient information to move faster,” Lagarde told an audience in Sintra, Portugal, about the period after that September hike.

However, there are growing questions about the future of monetary policy in the euro zone amid fears of a recession in the coming months. If the central bank were to move quickly in hiking rates, this could hamper economic growth even further at a time when a slowdown is already underway.

We are still expecting positive growth.

Christine Lagarde

ECB President

Recent business activity data suggests that the euro area is already losing steam. The overall question is whether the euro zone will manage to escape a recession this year, or if that will come in 2023.

Berenberg economists forecast an recession in the euro zone in 2023 with a GDP (gross domestic product) contraction of 0.8%.

However, further economic pressures from Russia’s invasion of Ukraine — most notably over energy and food security — could tip the region into a more proacted slowdown earlier than expected.

So far, European officials have avoided talk of a recession.

“We are still expecting positive growth rates due to the domestic buffers against the loss of growth momentum,” Lagarde said earlier this week. The ECB forecast in June a GDP rate of 2.8% for the region this year. New forecasts will be published in September.

However, policymakers in Frankfurt are aware that the economic slowdown is a major risk they need to monitor.

Philip Lane, the bank’s chief economist, said it needs to remain vigilant over the coming months.

“With the uncertainty, we have to manage the two risks,” Lane, who is also a member of the bank’s Governing Council, told CNBC’s Annette Weisbach Tuesday at the ECB’s Sintra Forum.

“On the one side, that could be forces that keep inflation higher than expected for longer. On the other side, we do have the risk of a slowdown in the economy, which would reduce inflationary pressure,” he added.

Speaking in a flash research note after the data release Friday, Andrew Kenningham, the chief Europe economist at Capital Economics, said that the 8.6% figure is “probably not enough to bring a 50bp rate hike (rather than 25bp) back into play for July.”

“As policymakers are increasingly uncomfortable with their negative-interest rate policy we expect to see bigger rate hikes from September, with the deposit rate rising to +0.75% by year-end,” he said.

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European Central Bank expected to hold steady as economy slows

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Christine Lagarde, president of the ECB, speaks at the Bank’s press conference in Frankfurt, Germany.

Boris Roessler | picture alliance | Getty Images

For some time, central-bank watchers have expected the ECB’s October meeting to be relatively unexciting, but the current mix of slowing growth and higher inflation could render it more eventful than originally anticipated.

Although big decisions on the future of the European Central Bank’s emergency stimulus package — the Pandemic Emergency Purchase Program — are unlikely to be revealed until December, investor interest will be focused on comments made by bank President Christine Lagarde in this Thursday’s press conference.

“We see scope for the ECB to continue its pushback against current market pricing in its communications at the meeting,” Spyros Adreopoulos, senior European economist at BNP Paribas, said in a recent note.

“The flipside of pushing back against market pricing is that we also expect Christine Lagarde to maintain that the current spike in inflation is largely transitory.”

The euro zone economy currently is facing multiple adverse economic shocks. Supply chain bottlenecks have created shortages of all sorts of goods and gas prices are at record highs. Despite these uncertainties the market is currently pricing in a first rate hike by the central bank at the end of 2022.

“The market will be keen to hear if President Lagarde … argues as strongly as ECB Chief Economist Lane that the market timing of lift-off is inconsistent with the new guidance,” writes Mark Wall, chief economist at Deutsche Bank.

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Earlier this month, ECB Chief Economist Philip Lane called into question whether interest rates would rise at the end of next year, given that the central bank has said it won’t lift rates until inflation is at 2% over the medium term.

“When you look at market prices of the forward interest rate curve I think it’s challenging to reconcile some of the market views with our pretty clear, straightforward forward guidance,” Lane said at an online event, according to Reuters.

Euro zone inflation hit a 13-year high in September, mainly pushed up by higher energy prices, rising car prices and higher costs for accommodation.

“While the rise in prices for ‘accommodation’ should be interpreted as [a] “catch up” price increase, rising car prices reflect supply side bottlenecks,” Dirk Schumacher said in a note to clients.

“The September figures provide tentative evidence that the catch up part of inflation is an one-off and therefore temporary, while the price pressure emanating from bottlenecks is, so far, not abating.”

Investors will be watching for any indication of a shift in the ECB’s thinking on the nature of the current spike in inflation. So far, the persistent narrative has been that “the current increase in inflation is expected to be largely temporary and underlying price pressures are building up only slowly,” as Lagarde stated in September. Any change to this assessment could be a real market mover as it would also imply a more hawkish tone inside the bank’s Governing Council.

So far, the majority of economists expect the ECB to err on the dovish side in an effort to prevent an unwarranted tightening of financial conditions when the euro zone economic recovery is slowing.

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Business

ECB Lagarde tapering announcement at December meeting, analysts say

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European Central Bank President Christine Lagarde during the live streaming of a press conference following the ECB’s governing council meeting.

Xinhua News Agency | Xinhua News Agency | Getty Images

LONDON — The European Central Bank will announce the reduction of its Covid-related stimulus in December, four analysts told CNBC amid an economic improvement in the euro zone.

In the United States, the Federal Reserve has already signaled it is likely to start tapering before the end of the year. Chairman Jerome Powell said last week that the U.S. economy is at a point where it does not need as much policy support as had been the case in the wake of the pandemic, though the pace at which asset purchases will be reduced is yet to be decided.

And in the euro zone, a similar announcement could be just around the corner.

“My guess is that they will probably do it in December,” Gilles Moëc, group chief economist at AXA Investment Managers, told CNBC on Wednesday.

The ECB is meeting on Sept. 9, but analysts think the central bank will wait a few more months before announcing what it will do about its Covid-related measures.

“I think they want to give themselves some time and have new forecasts,” Moëc said, before the ECB governing council takes a decision.

In addition to having new forecasts on the table, Chiara Zangarelli, European economist at Nomura, said the ECB will also want to see what happens with the pandemic in the coming months.

But as things stand, she said, “it would be hard even for the dovish” members of the ECB to postpone an announcement on tapering beyond December.

ECB Chief Economist Philip Lane also said in an interview last week that “September is very far away” from the current conclusion date of its Covid-related asset purchase program, thus suggesting an announcement on tapering could take yet a few more months.

Market players are monitoring key data releases to understand how the ECB might react.

Regardless of when PEPP might end, that’s not the end of the ECB’s role in terms of QE.

Preliminary data released Tuesday suggested the euro area experienced its highest inflation rate in a decade in August at 3% off the back of high vaccination rates and an easing of Covid restrictions in the region.

The ECB had said it was expecting a surge in consumer prices this year, though due to temporary factors. The central bank’s aim is to achieve a 2% headline inflation rate over the medium term. If higher inflation rates were to persist, this would add pressure on the ECB to revert its stimulus at a faster pace.

What it could look like

The institution led by Christine Lagarde developed a new asset purchase program in the wake of the coronavirus in March 2020 to support the euro zone. The Pandemic Emergency Purchase Program — known as PEPP — is due to end in March 2022 with a potential total envelope of 1.85 trillion euros ($2.19 trillion).

The program has given the ECB more flexibility, namely by being able to purchase Greek bonds, which did not fit the investment criteria to be bought under other programs.

“Whether PEPP purchases can fall meaningfully, I think it is a little premature, I think we will get an indication that PEPP purchases still remain very high throughout the fourth quarter before tapering in the first quarter,” Guillaume Menuet, European economist at Citi told CNBC’s “Street Signs Europe” Wednesday.

Moëc, from AXA Investment Managers, expects PEPP to be concluded in March  “but then the big conversation will be what to do with the APP.”

When the pandemic hit the euro zone in March of 2020, the ECB also kept its asset purchase program, known as APP, which has a current monthly pace of 20 billion euros. The central bank has been using this program in combination with PEPP to sustain the 19-member economy.

Salomon Fiedler, economist at Berenberg, told CNBC on Wednesday that the APP will probably last until 2023 and then a potential first-rate hike could take place in the fourth quarter of that year.

But, in the meantime, Zangarelli, from Nomura, said that the APP is likely to be extended in size once PEPP comes to an end. She expects these details to also be unveiled at the December meeting.

ECB’s Lane also said last week that “conditions to end APP are not there.”

“Regardless of when PEPP might end, that’s not the end of the ECB’s role in terms of QE. This is why we don’t need a huge lead time to think about it. Of course, we can’t leave it too late either. But six months is quite a lot of time. In the autumn, we’ll have to work through a lot of issues relating to what 2022 should look like,” he told Reuters.

What could derail a December announcement

“Covid, Covid, Covid,” Moëc, from AXA Investment Managers, said.

He said that the economic situation in the euro zone is benefiting from high vaccination rates and an overall prudency to avoid lifting all Covid restrictions. But even if the pandemic were to deteriorate in the coming months, he said that “the bar to maintain PEPP as it is today is very high.”

Across the wider European Union, 70% of the adult population has been fully vaccinated against the coronavirus.

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