ECB to end interest rate hike cycle as inflation slows.

Central banks around the world have been raising interest rates to control high inflation. However, as inflation starts to slow down, the European Central Bank (ECB) may stop increasing rates in the future.

The ECB is expected to raise its benchmark policy by 25 basis points this week, but insists that all future rate decisions will depend on data, given the current uncertainty about future growth outlook and inflation.

In a note to clients, Fritzi Köhler-Geib, the chief economist at German bank KfW, said:

“Weaker economic data, significant easing in energy markets, and the recent sharp drop in inflation suggest that the interest rate cycle should end soon. On the other hand, rising wage pressures and still-high inflation expectations call for caution.”

Recent inflation data shows prices are slowing down, but still increasing at high rates for consumers. The headline inflation rate is 6.1% year-on-year, and the core rate is 5.3%. This level of inflation concerns officials in Frankfurt, especially with wages continuing to rise. Therefore, upcoming ECB staff projections, to be released on Thursday along with their rate decision, will be important in assessing the situation. In a research note, Mark Wall, an ECB watcher at Deutsche Bank, said:

“The risks [for the terminal benchmark rate] are tilted to the upside of 3.75%”. The bank’s benchmark rate is currently at 3.25%. “Inflation was below consensus in May, but underlying inflation is still high and we expect upward momentum from tourism-related pricing in the summer. The ECB may have to wait until September and possibly later before it has robust evidence that underlying inflation is slowing enough to skip or pause the hiking cycle.”

QT Discussions Take a Back Seat

According to a CNBC report, discussions about quantitative tightening and the acceleration of shrinking the ECB’s overall balance sheet will likely not be part of the discussions amongst policymakers this week.

Last month in May, policymakers announced that they would stop reinvesting as part of their Asset Purchase Program (APP) from July 1. Started in mid-2014, APP is a bond-buying stimulus package that deals with persistently low inflation levels.

The top priority will be the direction of the economy and where it’s headed, as the European Union slipped into a technical recession during the second quarter of this year. However, the growth picture is uncertain. Although sentiment has improved over the last six months, it has yet to reflect in the hard data. In a research note, Natixis ECB watcher Dirk Schumacher said that “the lack of any clear sign of acceleration of the euro area economy could be explained by the fact that new clouds are rising at the horizon – just as the old ones have vanished. While companies report ‘equipment as a limiting factor’ being less of a problem in expanding production, a weakening of demand is increasingly seen as a problem.”

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