ECB Monetary Policy and US Growth in Focus

Yesterday afternoon, the European Central Bank met market expectations by raising interest rates 25bps. This brings the main refinancing rate to 4.25%, its highest level since October 2008 while the deposit facility rate now stands at 3.75%, matching the all-time high reached in 2001. US GDP figures for Q2 2023 surpassed expectations yesterday, hitting 2.4% – a considerable increase from Q1’s 2% print. This came well above the general market consensus of 1.8% and gives investors confidence over the resistance of the world’s largest economy, despite the tight fiscal and monetary conditions.

ECB Raise Rates 25bps

Yesterday’s decision represents the ECB’s ninth consecutive rate hike and comes as inflation levels remain well above Frankfurt’s 2% target rate. For example, core inflation (annualised) rose from 5.3% to 5.5% between May and June and remains just 0.2 percentage points off all-time high. Here, Lagarde stated that “domestic price pressures are becoming important drivers of inflation”, alluding to how service inflation will continue to cause a headache for policy markers moving forward, not least because it tends to be ‘sticky’. While core inflation is continuing to concern policy makers, eurozone headline inflation (annualised) slowed 0.6 percentage points between May and June to 5.5% as energy prices continued to subside. Nevertheless, despite falling headline inflation, the ECB’s monetary policy statement stated that “inflation continues to decline but is still expected to remain too high for too long”.

Moving froward, markets are now speculating on whether the ECB will continue to raise rates or whether they have reached their terminal rate. Money markets implied rate expectations are now pricing in just over a 50% chance of 25bps rate hike on 14 September. Here the ECB’s Policy Statement said, “interest rate decisions will continue to be based on its assessment of inflation outlook in light of incoming economic and financial data, dynamics of underlying inflation, and strength of monetary policy transmission”.

Lagarde Discusses Eurozone Growth

Regarding growth, Lagarde stated that “economic and inflation outlook remain highly uncertain”. As such, Lagarde continued maintaining that “the near-term economic outlook for the euro area has deteriorated, owing largely to weaker domestic demand high inflation and tighter financing conditions are dampening spending”. Lagarde comments come as Germany entered a technical recession earlier this year and growth concerns continue to make headlines. For example, earlier this week, the HCOB PMI Index for manufacturing, (which accounts for about a fifth of Germany’s economy), fell to 40.6 from 43.2 in May, marking its fifth consecutive monthly decline.

US Growth Surpasses Expectation

US GDP figures for Q2 2023 surpassed expectations yesterday, hitting 2.4% – a considerable increase from Q1’s 2% print. This came well above the general market consensus of 1.8% and gives investors confidence over the resistance of the world’s largest economy, despite the tight fiscal and monetary conditions. With the US raising rates by 25bps on Wednesday, the Fed’s benchmark rate is presently at a 22 year high, though with headline inflation continuing to fall, markets are weighing on whether this will mark the terminal rate. However, with growth remaining resilient, many economists are concerned that this will make the Fed’s challenge of brining inflation back down to its 2% target difficult.

Biden was quick to attribute the strong growth to his administration, stating that “It is Bidenomics in action, growing the economy from the middle out and bottom up, not the top down”.

With focus shifting from growth to interest rate expectations, the yield on the US 2-year T-bill (which is more sensitive to rate hike expectations) rose 10bps to 4.93%. This fed into pressure on equities with the S&P 500 and Nasdaq falling around 0.6%.