The ECB hikes interest rates; poor productivity growth and large profit margins delay disinflation
Our Chief Economist, Shweta Singh, shares her thoughts on the European Central Bank’s (ECB) June monetary policy decision.
The ECB raised the policy interest rates by another 25bps – a cumulative 400bps rate hikes, taking the deposit facility rate to 3.5%. The decision was made by a ‘very broad consensus’ among the Governing Council (GC) members and is in line with our and market expectations. The monetary policy statement was relatively dovish. For the first time since the ECB embarked on the most aggressive tightening cycle in their history, the central bank acknowledged some signs of easing in inflation and the effect of monetary policy tightening on the real economy.
More data needed
Our outlook is not as roundly optimistic; unlike the ECB, we don’t expect economic growth to improve later this year. Any boost to real income from lower inflation and easing supply chain bottlenecks will likely be offset by the lagged effect of monetary policy tightening.
The ECB has committed to hike again in July; it is not pausing. President Lagarde said they have more ground to cover. We think the ECB is getting closer to the end. We have pencilled in just one more increase of 25bps hike next month. While there are upside risks to this projection largely on account of the labour market being stronger than our expectations, we will wait for more data before we change our view.
Economic momentum is softening rapidly
Most other developed economies, including the US and the UK will also be on a weak economic footing later in the year, weighing further on Eurozone growth. Poor productivity growth and large profit margins will delay the pace and extent of disinflation, but the economic momentum is softening rapidly and the ECB will have to take note soon.
Diversification benefits
UK pension scheme investors will be aware of the implications for their funding position from higher gilt yields. However, higher government bond yields across other major developed markets are important too. Having an appropriate allocation to government bonds provides a scheme’s growth portfolio with diversification benefits which we think will be valuable as economic conditions weaken towards the end of 2023.
