David McNamara: ECB leaves door open to September hike despite unchanged July rates

There remains a very real risk the ECB could be embarking on a flawed policy path if additional inflationary pressures do not materialise and the economy weakens further in the face of tighter monetary policy

ECB president Christine Lagarde continued to stress the ECB would take a 'meeting-by-meeting' approach to any rate changes and it was not pre-committing. Picture: AP /Michael Probst

The July meeting of the ECB’s Governing Council saw the central bank leave its key interest rates unchanged and simultaneously leave the door open to a rate hike in September.

The deposit and refi rates were maintained at 2.25% and 2.40%, respectively. This was very much in line with market expectations. The decision to remain on hold was unanimous. 

However, ECB president Christine  Lagarde commented some governing council members did discuss whether the central bank should consider a hike. The meeting statement also showed the governing council remained concerned about the upside risks to inflation. It noted “uncertainty remains high, and the full inflationary impact of the energy shock has yet to play out”.

At the post-meeting press conference, Ms Lagarde continued to stress the ECB would take a “meeting-by-meeting” approach to any rate changes and it was not pre-committing. She said the current policy setting was “positioned adequately to wait”. In this regard, she noted there would be some key data published over the next few weeks that would inform its decision on whether to raise rates or not in September.

In response to whether markets have correctly priced in near-term rates, Ms Lagarde responded that “our understanding is that our reaction function is very well understood by markets”. 

However, it was also notable she said the ECB was not currently seeing the emergence of second-round effects and inflation expectations were “broadly anchored” to the ECB’s medium-term 2% target.

The market continues to anticipate further rate hikes from the ECB. However, pricing has become more volatile over the past week. In the aftermath of the meeting, futures contracts indicate the market now attaches about a 70% probability to a 25bps rate increase at the ECB’s next meeting on September 10 (it was nearer to 90% before the meeting). 

This suggests the market had envisaged a stronger signal from the ECB regarding a September hike. Further out, the market is pricing in another 25bps hike at the first meeting next year, and about 65bps of policy tightening overall. That is 20bps more than was expected at the start of the week. 

In short, the market appears to have become less sure about when and by how much the ECB will tighten policy further.

Given the communications from the ECB, it seems reasonable to factor in a 25bps rate hike over the coming months if the incoming data justify this policy action. 

Any additional policy tightening, though, from that point on, will be very much dependent on the duration of the Middle East conflict and emergence of the fabled ‘second round’ effects. 

As we have highlighted before, though, there remains a very real risk the ECB could be embarking on a flawed policy path if these additional inflationary pressures do not materialise and the economy weakens further in the face of tighter monetary policy.

• David McNamara is chief economist at AIB