ECB 'still has some way to go' with interest rate hikes

With another interest rate increase on July 27 all but assured, ECB Governing Council member Joachim Nagel has been vocal about the need for further tightening.

'Looking at the forecast, higher rather than lower inflation rates are to be expected,' said German Central Bank head Joachim Nagel.

The European Central Bank’s historic series of interest rate increases has not finished yet as upside risks to the inflation outlook predominate, Governing Council member Joachim Nagel has warned. 

While decisions beyond a planned hike this month remain data-dependent, “the way I see it, we still have some way to go,” said Mr Nagel in a speech in Frankfurt.  

“Upside risks to the price outlook dominate,” he said. “Looking at the forecast, higher rather than lower inflation rates are to be expected. 

For example, stronger-than-expected wage increases or profit margins could cause inflation to accelerate over the medium term.” 

With another interest rate increase on July 27 all but assured, ECB officials are trying to determine how far borrowing costs must rise thereafter to get inflation under control. Mr Nagel, who is president of Germany’s Bundesbank, has been vocal about the need for further tightening.

Underlying inflation in the eurozone quickened again in June, a setback for policymakers who are watching for signs that the 400 basis points of rate hikes enacted so far are starting to bite. While there is growing evidence that tightening is putting a brake on manufacturing activity, demand for services has remained robust.

Mr Nagel said he is confident that a “hard landing” for the economy can be avoided. He also said the ECB’s balance sheet should shrink “significantly” in the coming years.

“Monetary policy challenges in the future could require that more room for manoeuvre is available again,”  he said. 

“There’s a lot to be said for the central bank’s footprint on the market becoming much more manageable in the future. 

In particular, this would mean a significantly smaller balance sheet.” 

Meanwhile, investment bank Morgan Stanley has raised its forecast for the ECB's so-called terminal rate to 4% on the June inflation data. Morgan Stanley previously expected ECB's main interest rate would peak at 3.75%, following an expected 25-basis-points hike in July. 

"After updating our inflation forecast with the June data, and taking stock of recent commentary from policymakers at this week's ECB Forum on Central Banking in Sintra, we change our ECB call and now see a terminal rate of 4%," Morgan Stanley stated. 

In Germany, Europe's largest economy, an index of factory purchasing managers for June was revised lower, to show even worse deterioration than previously reported.

“Conditions in the manufacturing sector have undoubtedly worsened, but this is not a crash,” said Hamburg Commercial Bank chief economist Cyrus de la Rubia. 

It’s important to remember that new orders began falling from very high levels, and manufacturers haven’t resorted to job cuts yet.” 

However, Italy’s factories had their worst month since the height of the pandemic lockdowns in early 2020, adding to concerns that the eurozone’s third-biggest economy faces a sharp slowdown as the ECB keeps increasing rates. 

Bloomberg and Reuters