ECB raises rates once more, but future decisions look finely balanced
- At its monetary policy meeting on 27 July 2023, the European Central Bank (ECB) tightened monetary policy further, increasing key interest rates by 25 basis points (bps).
- The ECB moved away from an explicit hiking bias but left the door open to future rate increases, with ECB president Christine Lagarde commenting in the press conference that the September meeting could result in a pause or a hike.
- The ECB also announced that the remuneration of bank minimum reserves would be cut to zero.
ECB continues to tighten, but the outlook remains uncertain
At the conclusion of its July 2023 monetary policy meeting, the ECB increased all three key interest rates by 25bps, bringing the refinancing rate to 4.25%, the marginal lending facility to 4.50% and the deposit facility rate to 3.75%. The increases were in line with market expectations and represent the ninth hike in the current cycle, taking cumulative rate hikes to 425bps since July 2022.
Exhibit 1: The ECB deposit rate equals its all-time high of 3.75%, last seen in Q1 2001
While progress has been made on inflation, ECB president Lagarde cautioned against declaring victory prematurely, repeating that inflation is “still expected to remain too high for too long” and that “underlying inflation remains high overall”. There was acknowledgment that prior rate increases are being passed through to the economy, which is a necessary factor to bring inflation back to target.
ECB to remain data dependent
ECB meetings will have a short summer recess and return towards the end of September. The interim period will see the release of two sets of inflation data and the final GDP figures for the second quarter of 2023, which will help inform the ECB Governing Council’s decision making, alongside the next round of quarterly growth and inflation forecasts. President Lagarde repeatedly mentioned during the press conference that the options between a further hike and a pause were finely balanced but did firmly rule out the prospect of a rate cut.
Credit conditions continue to tighten
Earlier in the week, the ECB released its latest bank lending survey, which revealed a further tightening of credit standards for both consumers and business alike. Banks reduced property-related lending by 8% and general consumer lending by 18%, as higher policy rates deterred borrowers. A further moderate drop is expected in the third quarter, resulting in three consecutive quarters of tightened credit conditions. These developments, combined with the recent deterioration in forward-looking purchasing managers’ indices, raise question marks about the future trajectory for growth and could weigh against the need for further rate increases.
Exhibit 2: Eurozone banks report tighter credit conditions
ECB cuts remuneration of bank minimum reserves to zero
The remuneration paid to banks for their minimum reserves, which is currently in line with the deposit facility, will be cut to zero from 20 September. This is the second such reduction, with the remuneration having previously been reduced from the main refinancing operations rate in October 2022. The reductions aim to preserve the effectiveness of monetary policy and aid the full pass-through of interest rate decisions to money markets. The remuneration paid for excess reserves currently remains unchanged.
Implications for euro cash investors
The latest rate increase is good news for cash investors. J.P. Morgan Asset Management’s euro liquidity strategies are well positioned to benefit from higher rates, given the high levels of short-dated cash they carry. Deposit and repo rates should refix higher at the start of the new reserve period on 2 August, providing an initial boost to the strategies yield and increasing thereafter, due to the floating rate instruments held by the strategies. Higher reinvestment yields for term securities will also benefit the euro strategies over the coming weeks.
The outcome of the July ECB meeting was largely as expected. With the Governing Council now having a seven week recess before its next meeting, the market will be ever watchful on the key data releases to assess the likelihood of yet another rate hike, or a much anticipated pause by the ECB. The data dependency of the ECB remains key as the central bank weighs future data against the impact of previous monetary policy decisions that are yet to feed through to the wider economy. In this environment, we believe investors will be well served by our active approach to cash management that prioritises diversification and liquidity.