MUFG on ECB Rate Decision

Let’s start with the policy decision. The ECB held the deposit rate at 2.50%, as expected, with unchanged guidance. The statement highlighted both sides of the debate. There was emphasis on the larger and longer-lasting energy shock but also a new explicit reference to the impact from tighter financial conditions and the lack of second-round effects.

That gave the statement a cautious tone but overall it reads like justification for a pause at this juncture rather than an argument against further tightening. That was certainly backed up by Lagarde’s comments in the Q&A. She revealed that, although the decision to hold was unanimous, policymakers debated whether to hike at this meeting and suggested that current conditions “could have warranted" further tightening. While stopping short of pre-committing to December, Lagarde’s remark that the ECB’s “direction of travel” is clear points to at least one more hike to come, barring significant developments or shocks.

While market conditions were noted, there was little suggestion that higher market rates are viewed as a substitute for policy action. All told, given Lagarde’s comments, we see the decision as a hawkish pause which leaves the door wide open to further tightening. Our call remains that the ECB delivers a further 50bp of tightening, with 25bp hikes at the next projection meetings in December and March. That would push rates into mildly restrictive territory.

In line with the ECB’s assessment, we still see relatively little evidence that energy prices are generating second-round effects. But the duration of the energy shock increases the risk that price pressures will broaden. That risk will become increasingly difficult to ignore and we continue to think the argument for further action will ultimately win out, with some support from upcoming data.