In Brief

• At its monetary policy meeting on 15 June 2023, the European Central Bank (ECB) tightened monetary policy further, increasing key interest rates by 25 basis points (bps).
  
  
• The increases were in line with market expectations and represent the eighth hike in the current cycle, taking cumulative rate hikes to 400bps since July 2022.
  


• The ECB confirmed that it will stop reinvesting maturities proceeds from the asset purchase programme (APP) from 1 July 2023.

ECB will continue to tighten

At its 15 June 2023 monetary policy meeting, the ECB increased all three key interest rates by 25bps, bringing the refinancing rate to 4.00%, the marginal lending facility to 4.25% and the deposit facility rate to 3.50%. The increases were in line with market expectations and represent the eighth hike in the current cycle, taking cumulative rate hikes to 400bps since July 2022.

Exhibit 1: ECB deposit rate has reached a 22-year high of 3.50%

Source: J.P. Morgan Asset Management and Bloomberg; data as at 16 June 2023.

Nevertheless, the ECB still believes the inflation fight has not yet been won. At the subsequent press conference President Lagarde noted that the inflation outlook continued to be “too high, for too long”, and, although headline inflation has started to recede, “underlying price pressures remain strong”.

President Lagarde kept open the option of further hikes by stating that “future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target”.

The ECB Governing Council (GC) also confirmed that reinvestment of the APP maturities will cease from 1 July 2023. Pandemic emergency purchase programme (PEPP) reinvestments will continue until at least the end of 2024, with the GC applying a level of flexibility to avoid risks to the monetary policy transmission mechanism.

At the end of June, European banks will repay EUR 477 billion of targeted longer-term refinancing operations (TLTRO) loans. There will be no new bridging loan facilities provided by the ECB, to ease the burden on the banks that have the largest loans to repay. The GC believes that banks have had ample time to prepare and can utilise existing marginal refinancing operations (MRO) to fulfil any funding requirements if necessary.

Inflation revised upwards, growth forecast modestly lower

Headline inflation has been revised upwards and is anticipated to average 5.4% (2023), 3.0% (2024) and 2.2% (2025). Core inflation is also expected to be higher at 5.1% (2023), 3.0% (2024) and 2.3% (2025). The increase in the 2025 core inflation projection further above target was a hawkish surprise and supports further monetary policy tightening.

Several comments made during the press conference confirm the resilience of the employment market alongside evidence of increasing labour costs. These factors contributed significantly to the upward move in inflation forecasts and clearly need to be monitored closely going forward.

The ECB has reduced economic growth projections to 0.9% (2023), 1.5% (2024) and 2.3% 2025, which is consistent with the recent softening seen in quarterly growth from 2022 to 2023.

Exhibit 2: Headline inflation is falling but less volatile core inflation continues to rise

Source: J.P. Morgan Asset Management, Eurostat, ECB and Bloomberg; data as at 16 June 2023.

Not pausing just yet

President Lagarde reaffirmed that ECB decisions remain data dependent, but that there remains further ground to cover, despite strong evidence that “past rate increases are being transmitted forcefully to financing conditions and are gradually having an impact across the economy”. Lagarde went so far to say that a July hike is highly likely unless there is a material change versus the baseline forecast.

Exhibit 3: Eurozone unemployment and wage growth

%, wage growth is year on year

Source: J.P. Morgan Asset Management, ECB, Eurostat, Refinitiv Datastream; data as at 16 June 2023. Wage growth is based on negotiated wages.

Implications for euro cash investors

The latest rate increase is good news for cash investors. J.P. Morgan Asset Management’s liquidity euro 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 21 June, 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.

Conclusion

The outcome of the June ECB meeting was largely as expected. However, the higher inflation forecasts have increased the possibility of the terminal deposit rate reaching 4.00% during this hiking cycle. The data dependency of the ECB remains key as the central bank weighs future data against the impact of previous monetary policy that is yet to feed through to the wider economy. We believe investors will be well served by our active approach to cash management that prioritises diversification and liquidity.

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