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Could This Week’s CPI Prints Diminish the Chances of Further ECB Rate Hikes?

  • Inflation data in the spotlight as the market prices in rate cuts
  • The ECB kept the door open to more rate hikes, but growth remains a big thorn
  • German CPI due out on Thursday; the euro area aggregate on Friday (09:00 GMT)

Has the ECB hiked for the last time?

Contrary to the other key central banks, the ECB announced another rate hike at its September meeting. The statement and the accompanying press conference did not differ much from the message coming from the recent Jackson Hole gathering as President Lagarde, and numerous hawks after the meeting, has tried to keep the door open to another rate hike if needed. However, the market does not appear convinced as the next rate move is expected to be a rate cut. Understandably, most ECB doves have also come out, insisting that the ECB has done enough.

As the September ECB staff projections showed headline inflation dropping to 2.1% by 2025, and core inflation a tad higher at 2.2%, one can say that the ECB is probably not there yet. And at this point, the discussion about the growth outlook comes in. The market believes that a stagnant economy, and potentially a short-term recession, will persist, increasing the possibility of inflation slowing down even more aggressively. This expectation is mostly confirmed by the most recent PMI figures.

ECB is aware of the grim growth outlook

However, Lagarde made it clear that the ECB is aware that the rough patch will continue in the fourth quarter of 2023, spilling over into 2024 as well. And despite this grim outlook, the ECB opted to hike, potentially fearing that the current inflation deceleration could be temporary. Considering the oil price performance over the past two months, these fears could materialize going forward. Additionally, a couple of weeks ago we got an interesting comment from Bank of Japan member Tamura. He commented that Japan’s inflation is likely to slow for the time being, and then accelerate moderately again. If this applies to the euro area economy as well, then the ECB is probably sensible in keeping an open mind at this juncture.

Inflation still matters

In this context, on Thursday we will get the preliminary print for German inflation with the euro area aggregate figures released on Friday. Regarding Germany, the market is currently forecasting a significant deceleration at the annual pace of increase from 6.1% in August to just 4.6% in September. If confirmed, this will be the lowest headline figure since October 2021, a strong sign that the ECB’s monetary policy stance is working. Consequently, the euro area aggregate print is also expected to record a slowdown but less dramatic. The headline figure is seen easing to a 4.5% YoY growth from 5.2% in August, with the core component forecast to slow to an annual growth of 4.8%.

What does that mean for the ECB and the euro?

Unfortunately for the hawks, the ECB has reached the stage where an upside surprise in inflation is not sufficient justification for a rate hike at the next meeting. Other pieces of the economic puzzle i.e. growth outlook, wage developments and oil price action must align in order to increase the possibility of an inflation overshoot and eventually force the ECB to react. However, in the case of a stronger inflation print this week, the euro stands to benefit against the US dollar. A move towards the 1.0720 area could clearly please the euro bulls but these gains might prove short-lived if the incoming data continue to paint a grim growth picture.

On the flip side, the barrier for rate cuts remains high. However, certain ECB members have started to mention the word “cut” which suits the market’s intentions. We will gradually see more “rate cut” comments if there is a downside surprise at this week’s CPI figures. This outcome could bring forward the currently priced-in rate cuts and thus allow the euro-dollar pair to continue its aggressive downward trend. A break of the busy 1.0481-1.0571 area could open the door to a more protracted move towards 1.0315.

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