Potential pause for the ECB: Principal AM

Yasmine Raso

Senior Journalist, Financial Newswire

31 July 2023

While markets were unsurprised by the European Central Bank’s (ECB’s) 25-basis-point (bp) rate rise, its most recent policy statement has suggested it may shift its approach to a future pause.

Principal Asset Management’s Chief Global Strategist, Seema Shah, said a change in the language of the policy statement implies the central bank is satisfied with the “sufficiently restrictive” level of rates and “opens the door… to a future pause”.

“The shift also appears to acknowledge recent economic weakness, as well as the ECB’s latest quarterly bank lending survey, which showed that business demand for enterprise loans has fallen to its lowest level on record, surpassing measures during the Global Financial Crisis,” she said.

“Markets interpreted the slight change in language dovishly, as reflected by the slightly weaker Euro and a minor rally in short-end euro-area bonds.”

Despite European headline inflation in decline since October 2022, June’s reported figure coming in at 5.5 per cent and similar declines seen by the US Federal Reserve and the Reserve Bank of Australia, the ECB’s preferred inflation measure – Core MUICP – slightly increased in June and remains above the two per cent target.

Shah said the motivations behind inflation are changing as wages rise, profit margins grow stronger and unemployment decreases.

“Economic uncertainty remains elevated for the region, and policymakers must surmount a complex balancing act between weaker growth, elevated inflation, policy transmission risks and external international shocks,” she said.

“Today’s policy statement and press conference Q&A continually emphasized data dependence and offered little guidance on potential future ECB policy decisions.

“Ultimately, the ECB (as well as markets) will be watching to see if the current economic slowdown continues and if further progress on inflation ensues.

“The ECB will likely opt to pause its hiking cycle once these developments become more visible and persistent. Nevertheless, the outlook for future policy decisions in the euro-area will continue to be driven by data-dependency and bounded by uncertainty, for the foreseeable future.”