15/09/2023 “Is the door open or is the door closed? You know, there was a
beautiful theatre play by De Marivaux, who said that a door has to be either opened or
closed. But this is theatre…” Christine Lagarde meant Musset, of course, not Marivaux. And
she forgot to mention that a door can be very much ajar. The European Central Bank hiked
rates by 25bps, taking the cumulative total tightening to 450bps and the deposit rate to a
record high. But the message from the ECB was clear – it believes it has done enough and the
hiking cycle is over. In its statement the ECB said: “Based on its current assessment,
the Governing Council considers that the 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 target.” This was a clear and deliberate signal to
the market that the ECB thinks it is done for now. It was a dovish hike, pushing the euro
below $1.07, before extending losses as US retail sales and PPI inflation data came in a tad
hotter than expected. Some are calling this a low conviction pause, and several hawkish
members of the ECB’s Governing Council were out afterwards to say that they could hike again
in December if wages keep rising and inflation sticks around for longer. Certainly, Lagarde
made sure there is still a crack in the door for another hike, but it’s obvious that the GC
is fairly confident that it won’t or shouldn’t take it further. The question is now one of
duration- how long do you maintain rates here? Once more to the statement: “The
Governing Council’s future decisions will ensure that the key ECB interest rates will be set
at sufficiently restrictive levels for as long as necessary.” “As long as necessary”
points to the higher for longer mantra becoming entrenched. The messaging from the ECB will
be focused less now on whether another hike is needed, but for now long they stay here.
Again to Lagarde: “…both elements matter, the level sufficiently restrictive and the
duration. But it’s obvious that the focus is probably going to move a bit more to the
duration”. They will be wedded to higher rates and push against the idea of cutting
early, Lagarde saying in response to a question about being prepared to cut: “This
[rate cut] is not even a word that we have pronounced.” Markets, though, are not just
buying the end of the cycle but also pricing in cuts next year. The ECB is certainly not
declaring victory over inflation, but it is saying that the economic growth is going to
slacken enough to push down demand and prices. The fly in the ointment: aside from just wage
growth, it must contend with the new paradigm of lumpy inflation, deglobalisation, more
expensive and disrupted value chains and the very real potential for a protracted period of
stagflation. So, what about stagflation? Staff projections were unambiguous: inflation is
too high and growth is weakening. Its forecast for inflation in 2024 was raised to 3.2% from
3.0% predicted in June, whilst the growth outlook for next year was revised down
significantly to 1.0% from 1.5% in June. For 2025, the ECB sees inflation slowing to 2.1%,
below the 2.2% seen in June. The growth outlook was steady at 1.5% for 2025. Growth this
year was revised down to 0.7%, whilst inflation was revised up to 5.6% from 5.4% (bear in
mind that projections for the current year are largely historical and irrelevant to policy
making). Is it done? Given the rhetoric and the staff projections, inflation would now to
have to be significantly higher and/or stickier for the ECB to hike again. Christine Lagarde
was careful not to slam the door shut on the idea of any more hikes – “we can’t say
that now we are at that peak” – but it seems it’s only a little ajar. 
Neil
Wilson
Chief Market Analyst at Finalto
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