J.P. Morgan AM: Review of ECB meeting Thursday 10 September
Jorn Veeneman, Global Market Strategist at J.P. Morgan Asset Management, responds to yesterday's ECB meeting:
ECB raises deposit rate by 25 bps to 2.5%, while staff forecast revisions point to another hike in December
- The ECB raised the deposit rate by 25 bps to 2.5% at today’s meeting. Lagarde said the decision was unanimous within the Governing Council and that the rate hike was robust across the various scenarios in the ECB’s staff forecasts and policy framework. The decision follows a 25 bps increase in June and a pause in July.
- The Governing Council again stressed that it is not pre-committing to a particular rate path, given the continued high level of geopolitical uncertainty. As seen over the summer, and in the moves in 2-year German government bond yields (see Exhibit 4 of the preview), swings in energy prices have a direct impact on the inflation outlook. This widens the range of potential future policy responses from the ECB, as reflected in its scenario framework.
- Today’s rate hike was widely expected after resilient economic growth in Q2, continued momentum in Q3, and still high energy prices. Given this backdrop, and after Lagarde signalled at the July meeting that the “market seems to understand the ECB reaction function very well”, the September rate hike was fully priced by markets.
- However, unlike at the July meeting, Lagarde refrained today from giving hints about the future policy direction. When asked whether policy needs to move into restrictive territory, or whether she still agrees with the market’s perception of the ECB’s reaction function, Lagarde avoided giving more explicit forward guidance. Instead, she pointed to the ECB’s meeting-by-meeting and data-dependent approach, given the current environment of high geopolitical uncertainty. With markets now pricing in two more rate hikes, taking the deposit rate to 3.0% by the March 2027 meeting, Lagarde chose not to validate this hawkish signal.
- The changes in the newly released ECB staff forecasts, combined with the policy statement, point to another rate hike in December. Economic resilience led the ECB to upgrade its eurozone growth forecast for 2026 to 0.9%, from 0.8% in June, and for 2027 to 1.4%, from 1.2%. At the same time, the headwind from high energy prices led to an upward revision to headline inflation for 2027, to 2.5% from 2.3%, and a modest upgrade for 2028, to 2.1% from 2.0%. The statement was also more explicit about the persistence of inflationary pressures, adding that “inflation is set to remain well above target for an extended period”. Together with the baseline forecast showing core inflation still at 2.3% in 2028, compared with 2.2% in June, this keeps the door open for another rate hike in December.
- We still see this as consistent with the ECB’s measured tightening response to an inflation shock that is substantial, but not too persistent. In this scenario, eurozone GDP growth should be able to maintain a slightly above-trend pace in 2027. As mentioned in the preview, we do not expect the euro to strengthen materially, as the support from a higher deposit rate is offset by pressure on the eurozone’s terms of trade, given the region’s reliance on energy imports.
- For the ECB to raise the deposit rate beyond 2.75% and move policy clearly into restrictive territory, energy prices would need to remain high without hampering the growth outlook. We see this combination as unlikely. In addition, as Lagarde confirmed in the press conference, indirect and second-round effects from higher energy prices are not yet visible in either inflation or wage data. This raises the threshold for the ECB to tighten policy further after December. That said, the longer the war in the Middle East continues without allowing a more durable flow of energy products through the Strait of Hormuz, the greater the risk of more persistent inflationary pressures building.
- Our view of a December hike followed by a pause is more dovish than market pricing. Current market pricing points to the deposit rate reaching 3.0% by March 2027. Pricing for two more rate hikes has been pulled forward over the week as energy prices have risen, with Brent crude moving above 100 USD per barrel, its highest level since last May, and European natural gas rising above 80 EUR per MWh, its highest level since the end of 2022.
- Markets responded to the meeting by increasing policy rate expectations. In our view, this was mainly driven by the revisions to the ECB staff forecasts and partly by a further rise in Brent crude oil, which moved to 104.5 USD per barrel from 102 USD per barrel during the press conference. The expected policy rate for March 2027 increased by 12 bps to 3.0%, from 2.9%. Similarly, the 2-year German government bond yield rose by 8 bps to 3.14%, while the 10-year yield increased more modestly, by 3 bps to 3.48%. The euro traded broadly flat against both the USD and GBP.
