ECB raises rates once more, taking the deposit rate to a record high
At its monetary policy meeting on 14 September 2023, the European Central Bank (ECB) tightened monetary policy further, increasing key interest rates by 25 basis points (bps).
The deposit rate is now at its highest level since the inception of the euro.
The ECB gave the strongest signal to date that rates are now sufficiently high to return inflation to its target level, within a reasonable timeframe.
ECB provides a very strong signal that rates may have reached their peak
At the conclusion of its September 2023 monetary policy meeting, the ECB increased all three key interest rates by 25bps, bringing the refinancing rate to 4.50%, the marginal lending facility to 4.75% and the deposit facility rate to 4.00%. The increases represent a tenth consecutive move, and bring cumulative rate hikes to 450bps since July 2022.
Exhibit 1: The ECB deposit rate reaches an all-time high of 4.00%
Following the rate announcement, ECB president Lagarde gave the strongest signal to date that rates may have reached their peak, assessing that key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the 2% target. There was confirmation that prior rate increases are being forcefully passed through to the economy, tightening credit conditions and dampening demand, which are necessary factors to bring inflation back to target.
New inflation forecasts now predict higher inflation figures for 2023 (5.6%) and 2024 (3.2%), before falling back in 2025 to 2.1%. Higher fuel and food costs, resulting from adverse climate change, is the driving force behind the higher forecasts. Growth forecast were cut significantly to 0.7% in 2023, 1% in 2024 and 1.5% in 2025. Having stagnated in the first half of 2023, the eurozone economy will likely be subdued in the coming months, due to lower exports and a weakening of the services sector.
Opinions on the Governing Council remain mixed
Following normal protocol, ECB president Lagarde declined to comment on the vote split on the Governing Council between those members in favour of the rate increases, and those voting for a pause in the current cycle. Lagarde confirmed only that there was a solid majority in favour of further tightening, with the Governing Council viewing the risk to economic growth as being to the downside, before adding that any upside risk will come from stronger employment data and wage settlements.
In addition, Lagarde repeated her call for European Governments to rein in their fiscal stimulation measures, in lieu of additional central bank policy tightening. The Governing Council made no changes to the pandemic emergency purchase programme or the controlled roll down of the asset purchase programme, as it considers interest rates to be its main policy tool.
Business surveys, meanwhile, are indicating an imminent sharp slowdown in growth. The new orders component of the latest surveys was very weak, and incoming new business for the service sector is now contracting, mirroring new orders in the manufacturing sector. Should this trend continue, the latest rate hike will probably prove to be the last.
Exhibit 2: Eurozone GDP and purchasing managers’ index (PMI) contraction
Implications for euro cash investors
The latest interest 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 that they carry. Deposit and repo rates should refix higher at the start of the new reserve period on 20 September, providing an initial boost to the yield of the euro strategies, with further increases expected thereafter due to the floating rate instruments that the strategies hold. Higher reinvestment yields for term securities will also benefit the euro strategies over the coming weeks.
The outcome of the September ECB meeting was described by many as being on a knife edge, but ultimately the hawks prevailed, backed by concerns that inflation was not returning to target in a timely enough manner. The decision was not unanimous and, with the near-term growth outlook looking increasingly bleak, the ECB’s focus is shifting towards how long rates will be required to stay at 4%, rather than on further rate hikes.
With the peak in rates likely now upon us, we believe investors can be more comfortable adding some rate risk, while maintaining an active approach to cash management, prioritising diversification and liquidity.