MNI SOURCES: Growth Outlook Darkens As ECB Heads For June Hike

The European Central Bank is increasingly concerned about the outlook for growth even as it heads towards a likely 25-basis-point rate hike in June, with weak demand likely to reinforce policymakers’ determination to remain data-dependent as they tackle not only an energy shock but global trade headwinds, Eurosystem sources told MNI.

While officials see upside risks to headline inflation from the Iran conflict, sources noted that consumption is already weak, savings rates high and that recent services PMI data in particular have been concerning. June’s hike cannot be framed as the first in a series, they stressed

“We know inflation will remain elevated for a while and that core inflation is likely to move somewhat higher. The challenge is to avoid killing the economy while at the same time preventing inflation expectations from becoming de-anchored,” one source said, adding that “There is strong resistance to describing a June move as the beginning of a new hiking cycle.”

Officials broadly expect June staff projections to show slightly higher headline inflation and somewhat weaker growth compared with March, though core forecasts may not move dramatically. 

“Undoubtedly upside price risks have risen, but the downside growth risks have probably increased at a greater rate,” a source said. “That will be reflected in the projections, no doubt with headline inflation a little higher than in April, with growth down a few tenths. I'm not sure core will be too far from the April view. We think the scenarios remain between baseline and adverse, but not as close to the baseline as in April.” (See MNI SOURCES: ECB Set To Hike In June, Then Keep Options Open)

The ECB is focusing on granular price-setting data and measures of inflation expectations among firms as it monitors the feedthrough from higher energy costs, with officials cautioning that household surveys may overstate medium-term inflation risks because of lingering memories from the 2022 energy crisis.

POLICY ERROR

“What happened in 2011 is still very present in people’s minds,” a source said, referring to what he considered to be that year’s mistaken rate hikes, “Oil prices surged, the economy then entered recession and monetary policy had to reverse course.”

Another official made a similar point, noting that “data dependency is also a good argument against the charge of acting hastily and setting up for what could look like a policy mistake. Just because it is right on incoming data to hike in, say, June, that doesn't mean a significant shift in data precludes a reversal in September or December.”

While producer price and input cost data already shows some passthrough from more expensive energy, wage growth pressures remain limited or are even moderating. With the economy facing additional headwinds from weaker global trade, U.S. tariffs and Chinese competition, officials will be keeping a close eye on consumption data. 

“What consumers usually cut first are discretionary goods, travel and durable consumption, so those sectors could suffer quite a lot,” a source said.

In the ECB’s accounts of its May meeting published on Thursday, Governing Council members noted how the outlook for eurozone economic activity had worsened since the start of the conflict.  There was some concern that private consumption could become weaker than expected owing to the combination of higher energy prices and a drop in consumer confidence, though the labour market and wage growth remained broadly supportive.

FINANCIAL CONDITIONS

Meanwhile, tightening financial conditions are already exerting some disinflationary pressure, the official argued.

“That mechanism works as long as market expectations remain broadly aligned with the Governing Council’s view and with the baseline outlook,” he said, “For the moment market pricing looks reasonably balanced given what we know today, but there can be no pre-commitment on the future path of rates.” (See MNI INTERVIEW: Any June Hike Not Cycle Start-ECB's Patsalides)

Sources stressed that the situation for the eurozone is very different to that of the energy price shock following the Russian invasion of Ukraine in 2022, when demand rebounded in the wake of Covid and governments retained greater fiscal capacity to support businesses and consumers through higher prices. 

Overnight Index swaps currently price in about 63 basis points of tightening by the ECB’s December meeting. A 25-basis-point hike on June 11 is almost completely priced in.

An ECB spokesperson declined to comment.