European Central Bank (ECB) policymakers are growing increasingly concerned about the weakening growth prospects. There is a growing momentum for a pause in rate hikes, according to eight sources with direct knowledge of the discussion. The ECB has been raising rates at each of its past nine meetings to control inflation. However, the recent major economic indicators have fallen below expectations, indicating the possibility of a recession. The “pause” camp is gaining support among policymakers, although the debate is still ongoing. None of the sources believe that a rate hike is the most likely outcome, even if it is their preference. This is a significant shift from six weeks ago when a rate hike was seen as the most likely scenario for September.
Even if there is a pause in rate hikes, the ECB will need to emphasize that its job is not done and further policy tightening may still be necessary. It could take several months, possibly until early 2024, to be confident that euro zone inflation, currently at 5.3%, is moving towards the central bank’s target of 2%. The debate among policymakers remains open, and no final decision will be made until after the next inflation reading on August 31 and the ECB’s new economic projections. The ECB’s next meeting is scheduled for September 14.
Market expectations are currently divided between a rate hike in September and a pause. However, it is anticipated that the ECB will eventually implement a final 25 basis point hike to 4% later this year. Arguments for a pause in rate hikes include concerns about a potential recession, the deteriorating growth outlook in China, and benign wage growth. Some policymakers caution against relying too heavily on sentiment surveys, as there has been a discrepancy between sentiment readings and actual data. Employment continues to grow, and the jobless rate is at a record low, suggesting a strong labor market. This contradicts historical patterns where significant disinflation is accompanied by rising unemployment. Advocates for a pause argue that negotiated wage growth is still relatively low and workers are trying to recover from years of high inflation. On the other hand, proponents of further tightening believe that underlying inflation has plateaued and a significant decline is needed to justify a pause. They want solid evidence that inflation is heading back to the target without the risk of remaining above 2%.
In conclusion, ECB policymakers are increasingly leaning towards a pause in rate hikes due to concerns about deteriorating growth prospects. However, the final decision will depend on upcoming inflation readings and economic projections. The ECB will need to emphasize that its job is not done and further policy tightening may still be necessary. Market expectations are divided between a rate hike and a pause, but it is anticipated that a final rate hike will be implemented later this year. Arguments for a pause center around recession fears, China’s growth outlook, and benign wage growth, while proponents of further tightening believe that underlying inflation has plateaued.
