The European Central Bank (ECB) has met market forecasts and announced a new interest rate hike in the Eurozone, the seventh since last July, but this time by only 25 basis points.
With this new increase, the interest rate for refinancing operations will stand at 3.75%, while the deposit facility rate will reach 3.25% and the marginal lending facility rate will reach 4% as of May 10.
Despite the fact that the price of money is at its highest level since October 2008, the monetary and financial authority has slowed the pace of rate hikes. At the Governing Council meeting on May 4, the increase in the three reference rates was barely a quarter of a point, compared to the 50 basis points applied in the last four meetings, as expected by analysts, since the impact of monetary restrictions is already being reflected both in financing conditions (tighter) and in the demand for credit. However, further hikes are still expected in the coming months in the face of inflation that is still very high and far from the ECB's target. The turning point could come in the summer.
The rate hike announced at this meeting will become official on May 10, bringing the price of money to 3.75%. However, it will not be the last increase.
As ECB President Christine Lagarde explained at the press conference following the ECB Governing Council meeting, "the inflation outlook remains too high and has been too high for too long. The latest available information broadly supports the Governing Council's assessment of the medium-term inflation outlook made at its previous meeting. Although headline inflation has declined over the past few months, underlying price pressures remain strong. Future decisions will ensure that policy rates are set at sufficiently restrictive levels to bring inflation back to the 2% medium-term objective in a timely manner and remain at these levels for as long as necessary."
Advance data from Eurostat, the EU statistics office, put the headline inflation rate in April at 7%, one tenth above March, while reducing the underlying rate (which excludes the volatility of energy and food prices, as well as alcohol and tobacco) by one tenth, to 5.6%. In any case, prices continue to grow at a level well above what the guardian of the euro considers optimal (2% in the medium term).
With this inflationary scenario on the table, analysts and economists take it for granted that there will be more interest rate hikes and that they could exceed 4% in the coming months, as they already predicted in March.
According to a Bloomberg survey, the ceiling for rate hikes could come in July, when the deposit rate could reach 3.75% (half a point above the current level) and which would therefore bring the interest rate for refinancing operations up to 4.25%, to remain stable at these levels until the autumn.
Along the same lines, the investment firm Renta 4 insists that "the market is discounting the arrival of the 3.75% deposit rate, although everything will depend on the extent to which inflation can be moderated and brought towards the ECB's target, taking into account the recent "hawkish" (restrictive) speeches of different members of the organization, such as Lagarde herself".
For economist Miguel Cordoba, it is obvious that money price hikes will continue since "the interest rate differential between the dollar and the euro is detrimental to the exchange rate and in Europe we have to pay for oil and gas in dollars. Therefore, we have to follow the path of the US Federal Reserve and there is still a lot of difference". At this week's meeting, the Fed also raised rates by 25 basis points, to a range of 5%-5.25%, a 16-year high.
According to Cordoba, the ECB will have to raise interest rates to 4%-4.5% as long as inflation remains high, although after that he foresees "a few months of plateau while inflation stabilizes and then a gentle decline to levels of 2-3%, which would be the most reasonable for European economies over the next three years". And he agrees that stabilization of money price increases could come by this summer.
Some members of the ECB Governing Council have been in favor of continuing to raise interest rates at least until July. One of them is Klaas Knot, governor of the Bank of the Netherlands and considered one of the main representatives of the most restrictive or 'hawkish' current, which in the last weeks has advocated increases at the June and July meetings, in addition to the one already applied in May,if core inflation shows no signs of easing.
On the other hand, Ricardo Zion, professor at EAE Business School, is inclined to believe that rate hikes will continue until the end of the year, although he does acknowledge that the pace of hikes will slow down from now on. "Inflation is still very high in Europe (slightly less so in Spain) and the ECB must continue to raise rates in order to calm it down; in Europe we are lagging behind the US and, as long as rates continue to rise, we will do the same here. There may be a slowdown in rate hikes, but the restrictive monetary policy is still necessary," insists the expert.
What is certain is that future decisions will be contingent on factors such as the evolution of inflation, the war in Ukraine, the impact of the drought on food prices and financing conditions, as Lagarde advocates.
"The Governing Council will continue to apply a data-dependent approach to determine the appropriate level and duration of tightening. In particular, the Governing Council's decisions on policy rates will continue to be based on its assessment of the inflation outlook in light of new economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission," the French leader insisted at the press conference.
Another vector that will mark the ECB's roadmap, and that of the other major central banks, is the state of banking health and the possible economic downturn. "If we continue with the current inflation data, I believe that interest rates should continue to rise, but 20% of US regional banks are clearly at risk of bankruptcy and collapse and, therefore, bank defaults and the possible recession will be taken into account in order not to raise them," says Manuel Romera Robles, director of the financial sector at IE Business School. In his opinion, the possible pause in the upward trend in rates will depend on the health and stamina of the banks. "Inflation has to be controlled without breaking the banks and without there being too much recession, and that balance is very difficult," he adds.
The direct consequence of the rise in interest rates is that new financing will become more expensive for both families and companies, as well as for variable mortgages already signed that are indexed to the Euribor.
As Juan Villén, general manager of idealista/hipotecas, explains, "the regulator seems to be identifying signs that its anti-inflation measures are beginning to bear fruit, as we have seen with the 26% drop in the number of home purchase mortgages granted announced by notaries public, and therefore considers that it is not necessary to maintain the strong pace of rises, although it continues its upward roadmap. In this context, the impact on the evolution of the Euribor is uncertain, as it is possible that the market interprets that we are reaching the end of the rises, and begins to discount - 12 months ahead - rates similar to or even lower than the current ones. In spite of this, the current levels of the Euribor are going to mean increases in repayments for all families with variable-rate mortgages, and new mortgages will continue to be considerably more expensive than a year ago. That said, we are still seeing how some banks, as a result of their need to attract customers and the almost non-existent remuneration of deposits, continue to offer fixed or mixed mortgages at rates below Euribor, which means that they remain the preferred options for consumers.
Regarding the 12-month Euribor, the Savings Banks Foundation (Funcas) rules out for the moment a sharp decline in the short term and forecasts an annual average of up to 4.25% this year and 4% in 2024, which leaves the door open to exceeding these levels in the short term (at least until there is more certainty about how much more interest rates will rise).
More expensive financing could push back demand for new loans from households and businesses, such as has happened in the first months of the year. According to a survey conducted by the ECB itself, euro zone banks reported a substantial tightening of their lending conditions in the first quarter of 2023, which exceeded the banks' own expectations. Thus, the demand for credit from companies plunged at the fastest pace since the 2008 crisis and that for mortgages remains close to historic lows.
And a potential drop in demand for financing will have a direct impact on the housing market, as it could complicate many sales. For this year, at least, transactions are expected to fall by up to double digits.
Every six weeks or so, the Governing Council of the institution holds a meeting at which it makes a monetary policy decision and it is there that it announces whether rates will rise, fall or remain the same. The dates of the next ECB meetings where further interest rate hikes could be announced are as follows:
#ECB # rate hikes # market # summer pause # European Central Bank # eurozone # refinancing # deposit facility # marginal lending facility # inflation # summer.