By Balazs Koranyi and Francesco Canepa
FRANKFURT, July 23 (Reuters) – The European Central Bank is all but certain to keep interest rates unchanged on Thursday but will hold the door wide open to another rate hike in September, as a fresh jump in energy prices threatens to put more upward pressure on inflation.
The ECB raised rates in June and hinted at more to come but a string of benign data on prices, wages, economic activity and inflation expectations in the weeks since has made a quick follow-up step less urgent.
But with oil prices back above $90 a barrel as conflict continues in the Middle East, the euro zone central bank may be forced back into action by the autumn to prevent the energy shock setting off a broader price spiral.
“We think the ECB will enter a hawkish pause,” Oliver Rakau at Oxford Economics said. “Current data would narrowly favour additional policy tightening down the line, in line with the June forecast and broadly validating market pricing.”
Financial markets now anticipate between two and three more rate hikes, with the first move fully priced in by October and the second by next April.
This pricing reflects oil prices more than fundamentals, however, and most economists say the 21-country euro zone will need far less policy tightening to keep a lid on inflation.
“Even with the current oil price, inflation will be just about at target next year, moderately undershooting later in the year,” Morgan Stanley’s Jens Eisenschmidt said.
“If you believe in that forecast, then there is no reason to hike more than twice,” he said. “At 2.5%, the deposit rate will be mildly restrictive, so it’s quite easy to justify a cut from there, if you’re approaching the target.”
NO SECOND ROUND EFFECTS YET
Given this mixed outlook, ECB President Christine Lagarde is likely to attempt a balancing act on Thursday.
She will want to signal that policymakers remain concerned about price pressures and further monetary policy tightening remains on the cards. But she needs to avoid stoking market expectations as much such action is already priced in.
The key reason the ECB can afford to be patient is that long-feared second-round effects of the energy price spike have yet to materialise.
High energy costs tend to raise the price of all goods and services and eventually force workers into demanding higher wages, setting off a vicious wage-price spiral.
But wage growth is continuing to ease, the labour market is relatively soft — particularly in Germany, the bloc’s biggest economy — and firms surveyed by the ECB are anticipating even more muted pay pressures.
Consumers have dialled back their price expectations, while detailed figures are showing next to no evidence of second-round effects. Services inflation actually slowed last month.
Moreover, continuing trade tensions, high energy costs and China’s expansion into some of Europe’s key export markets suggest that the bloc’s industries will continue to struggle for years to come, putting downward pressure on labour demand.
NEW FOOD INFLATION COMING?
Policymakers nevertheless argue that even if second-round effects are smaller and delayed, they are still coming and the ECB needs to be ready to act.
Scorching summer weather in much of Europe this month is also a potential risk. The heat may have damaged crops and could push up food prices, while low water levels on key rivers could create shipping bottlenecks.
“While food inflation has generally trended lower in recent months, reflecting softer prices for commodities such as sugar, cocoa and coffee, an unusually warm summer in Europe, combined with the effects of El Niño, could renew upward pressure on food prices,” Barclays said in a note.
(Reporting by Balazs Koranyi; Editing by Catherine Evans)
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