MFN - The ECB turns data dependent

In this Macro Flash Note, GianLuigi Mandruzzato looks at the result of the last ECB meeting and the implications for the path of monetary policy.

The ECB raised interest rates by 0.5% in March, as anticipated despite recent developments in the international banking sector. However, it acknowledged that recent events increase uncertainty regarding the economic outlook. It therefore refrained from giving precise indications about the outlook for policy.

President Lagarde stated that henceforth monetary policy will be decided based on new information, focusing on three elements:

• The assessment of the inflation outlook based on economic and financial data.
• The dynamics of underlying inflation, that is, excluding energy and food prices.
• The intensity of the transmission of past interest rate increases.

Despite the lack of precise guidance, the observation that inflation is expected to “stay too high for too long” indicates that the ECB maintains a tightening bias. During the press conference, President Lagarde also clarified that if new data supported the ECB’s base case scenario despite the greater uncertainty that has emerged in recent days, the Governing Council knows it has “more ground to cover" in raising rates to a level that is adequate to bring inflation back to the 2% target.

In light of the latest high inflation data, this is not surprising and likely keeps the option of further interest rate increases at the heart of the ECB’s internal debate (see Chart 1). At the same time, barring a rapid resolution of financial sector tensions, the pace of increases is likely to be more moderate in the coming months than at the beginning of the year.

Source: Refinitiv and EFGAM calculations. Data as at 17 March 2023.

Market expectations embedded in short-term rate futures contracts price in no more than two further rate increases of 0.25% and suggest that rates will peak during the third quarter of 2023 (see Chart 2). President Lagarde’s comments and the high probability that inflation will be much higher than 2% for some more time make this scenario perhaps too optimistic. It would not be surprising if, in the coming weeks, market expectations of eurozone interest rates are revised upwards, while remaining lower than the peak seen before tensions emerged in the financial sector.

Source: Refinitiv and EFGAM calculations. Data as at 17 March 2023.

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