Governing Council meeting, ECB 27/07/2023

Governing Council meeting, ECB. 27^th July 2023

ECB raises rates by a further 0.25%

The ECB’s Governing Council raised all three of its key interest rates by a further 0.25% at its meeting on 27^th July, as widely expected. This is the ninth back-to-back increase in the cost of borrowing in the space of less than a year, with the main refinancing fixed rate having now risen by 425bps to 4.25% in total - an unprecedented cycle of tightening. Consumer price inflation is falling, with the annual rate standing at 5.5%, the lowest reading since March 2022. Nonetheless, in the words of the ensuing press release, it is “still expected to remain too high for too long.” A reduction in energy prices is the main reason why inflation fell in June. The core inflation rate (excluding food and fuel prices) rose from 5.3% to 5.5%, although prices at the factory gate (the producer price index) turned negative in May. ECB President Christine Lagarde insisted that the ECB was committed to returning inflation to its 2% target. While avoiding any explicit commitments, a tweak in language that rates ‘will be set at sufficiently restrictive levels for as long as necessary’ clearly left the door open to further rate hikes later in the year.

Maturing assets purchased under the 2019 Asset Purchase Scheme are no longer being reinvested, which should shrink the ECB’s balance sheet by €25b. per month. Although in theory, no assets purchased under the much larger 2020 Pandemic Emergency Purchase Programme will be run off before the end of 2024, the ECB stated that “the Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.

Revisions to the GDP figures for Q1 2023 suggests that the 20-nation bloc is not in a technical recession after all, although the economy did not grow in this period; it merely flatlined. The money numbers do not offer much hope of any improvement. Broad money increased by €6.5b. in June, which works out at an annualised rate of less than 0.5% and follows on from four months of decline. The annualised quarterly growth rate has been negative since December and the annual growth rate has fallen to 0.6%, the lowest such reading since July 2010. Demand for credit is slowing, both from consumers and businesses. Mortgage lending was growing at an annual rate of 3% in April. June’s figure was a mere 1.3%. In the same period, growth in new loans to non-financial companies declined from 3.8% to 2.4%. Only nine months ago, this figure was 7.3%. Households are feeling the pinch, with retail sales static in April and May after two months of decline. The spread in bond yields is much narrower than during the sovereign debt crisis, with less than 200bps separating Germany from Greece and Italy. This, however, is primarily caused by the weakness of the German economy, which currently is in a recession. Only the stock market, which has increased by 17.2% since the start of the year, remains buoyant.  

Mme Lagarde is has openly admitted that the Eurozone economy is likely to remain weak “in the short run.” This is seen as a price worth paying to bring inflation back down to 2%. By ignoring the effects of higher borrowing costs on broad money, however, the ECB is in danger of provoking a far more severe and long-lasting downturn than it appears to be anticipating.