Focus on ECB interest rates

John Fahey

The second half of this year is likely to provide further evidence that global monetary policy is gradually shifting into a tightening phase.

The US Federal Reserve is advancing steadily on a path of policy normalisation, hiking rates at a measured pace and reducing the size of its balance sheet as its stock of QE assets are allowed to slowly run down.

Other central banks, though, remain cautious about tightening policy too quickly. Hence, monetary policy is expected to remain loose in all major economies over the next couple of years, apart from the US.

In the UK, the persistence of high inflation saw the Bank of England increase rates last November for the first time since 2007, by reversing the 25 basis points cut made in 2016, thereby bringing the bank rate back up to 0.5%. However, a much quicker than expected decline in inflation this year, combined with weak GDP figures, have seen the Bank of England keep policy on hold so far this year.

Nonetheless, the bank continues to indicate that a modest rise in rates is likely to be required over the next couple of years. The next rate hike could come as early as August, given recent signs that the UK economy is regaining momentum.

Meanwhile, the ECB scaled back asset purchases under its QE programme at the start of 2018. It indicated, last month, it will reduce them further in the fourth quarter and then cease net asset purchases altogether at the end of the year.

The ECB also indicated that it intends to keep interest rates at their current very low levels until at least the end of next summer. The ECB does not see inflation rising to its 2% target level in the next three years, so eurozone interest rates are likely to remain low for a long time.

Meanwhile, the Fed hiked rates by another 25 basis points to 1.875% at its June meeting, the seventh rate rise in this cycle. It indicated that two further rate hikes could be expected in the second half of the year, with further increases likely in the subsequent two years, taking rates up to 3.4% by the end of 2020.

The market is still a bit away from pricing in two full rate hikes in the second half of this year. We expect that continuing strong growth by the US economy over the next year will force the market to re-evaluate its view on rates and price in further policy tightening.

John Fahey is senior economist at AIB


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