09/18/2023

In a decision that deviated from a minority of Governing Council members and the recent decline in economic data, the ECB opted to increase the deposit rate (along with the main refinancing rate and the rate on the credit facility) by 25 basis points to 4.0% last week. All indications suggest that this will be the ECB's last rate hike. The change in the institution's statement contributes to this interpretation. By stating that it “considers that key interest rates have reached a level which, if maintained for a sufficiently long period, will contribute substantially to a timely return of inflation to the target level”, the Governing Council indicates that the focus of policy is shifting from the maximum level of interest rates to the duration of monetary tightening.

However, President Lagarde stressed at the press conference that a scenario of further interest rate hikes cannot be ruled out either. While it seems unlikely that oil prices alone could trigger further rate hikes, a combination of increased energy prices, improved economic growth and significant wage increases could raise concerns among members of ECB about possible second-round effects and inflation expectations. Therefore, we cannot definitively conclude that we have reached the end of the European Central Bank's tightening cycle.

Data released last week in the United States continued to demonstrate strength , with both retail sales and industrial production in August displaying unexpected resilience. In the world of prices, the August CPI showed a broad-based acceleration in headline and somewhat more modest acceleration in core. The latest reading of headline CPI highlights the inflationary threats presented by increased oil prices, resulting in a growth of inflation to 3.7% year-on-year from 3.2% in the preceding month. Core CPI details indicate that the decrease in inflation is happening more gradually and is not as widespread as the June and July data suggested.

How will the Federal Reserve respond? A pause during Wednesday's meeting seems very likely, drawing market attention to the famous dot plot that will show whether FOMC members still expect another rate hike between the November and December meetings. With inflation pressures remaining high relative to pre-pandemic levels and favorable economic and labor market conditions, it is likely that a final 25 basis point rate hike will be signaled, followed by an extended pause lasting until at least the first half of 2024.

The signs observed in the Chinese economy provide compelling evidence that economic activity may have leveled off in the Asian powerhouse. The year-on-year inflation rate returned to positive territory, and retail sales and industrial production improved from last month's readings and analysts' expectations. Overall financing and new bank lending were also better than expected. Declines in real estate investment and sales also moderated slightly. The increase in activity is a direct result of the government's various measures to stimulate the economy, such as issuing more government bonds and reducing the reserve ratio for banks as mandated by the People's Bank of China. In the past few weeks, the government has announced additional measures to provide stimulus to the housing sector. These measures include lowering mortgage rates for existing first-time home loans, relaxing mortgage payment regulations, and reducing down payment requirements for individuals entering the housing market for the first time. If the next few weeks continue to point in this direction of economic recovery in China, it will be very good news for the European economy and global economic growth, even though pressure on energy prices and inflation may increase.