The European Central Bank meeting takes center stage today. Going into the blackout period leading up to the meeting, polls pointed to a nearly even split between analysts’ calls for a pause and those for an increase. We think the ECB hawks will have their way today, pushing for one last hike, but it’s very close.
From a market perspective, the probability of a hike has increased from 40% at the beginning of the week to over 60% now, with 16 basis points discounted on the OIS forward. A Reuters source had tipped the balance, reporting that the ECB’s new inflation forecast for 2024 would be above the 3% that had been forecast in the last update in June.
However, the benefit to rates from a hike today could be limited. On the one hand, we have seen that the yield curve already supports quite a bit of flattening as an increasing probability of an eventual rise was built in; Looking beyond today, towards the end of the year, 25 bps are already fully discounted. Raising rates today would likely be largely interpreted as advancing that final hike, but the desire to price in further adjustment on top of that may be limited. After all, the tenuous macroeconomic story is not going away, and with a likely downgrade of the ECB’s own growth projection, the weaker backdrop should also gain more weight in the governing council’s own deliberations.
Markets may feel that this is the end of the interest rate hike cycle. Still, the ECB is likely to want to counter the idea that this is the end of its overall inflation-fighting efforts. We believe the degree of success of this will determine the degree of flattening of the bearish curve we will get in the event of a rally. A renewed focus on quantitative tightening could help shore up longer-term rates on a relative basis.