Pause for thought? Why the ECB may hold rates for now

Comments by Franck Dixmier , Global CIO Fixed Income at AllianzGI, ahead of the ECB monetary policy meeting on 26 October.

• We expect the European Central Bank to leave rates unchanged at its October meeting to allow time to assess the impact of tightening monetary conditions.
• In our view, the pause won’t mark a sign of things to come as the ECB has not yet reached the final level in its cycle of rate rises.
• Markets have not yet priced in the risk of further rate hikes and any readjustment in expectations will fuel volatility in bonds.

After raising rates at every meeting since July 2022, we expect the European Central Bank (ECB) to pause – and leave them unchanged at its meeting on 26 October. Recent macroeconomic data and a backdrop of heightened geopolitical tensions strengthen the case for a pause. Inflation is decelerating, to 4.3% in September from 5.2% in August year-on-year, and growth is slowing in the euro zone. But the pause won’t mark a sign of things to come.

The ECB cannot yet declare victory over inflation,

as President Christine Lagarde emphasised at the International Monetary Fund’s annual meeting in Marrakech.[1] Underlying inflation is still high, at 4.5% year-on-year in September,[2] due in particular to a wage-price loop that is not yet under control. In addition, the crisis in the Middle East is rekindling the risk of a supply shock linked to the rise in oil prices. The ECB's latest inflation forecast, communicated at its meeting on 14 September, projected a barrel of oil at USD 82.7 in 2024 and USD 77.9 in 2025. These assumptions now seem very modest.

We expect the euro zone central bank to adopt a neutral stance on Thursday, insisting that it will be guided more than ever by macroeconomic data and the associated risks.

In our view, the ECB has not reached its terminal rate.

While its sole mandate is price stability, the heightened risks of recession should not put a brake on further rate hikes. And we believe that long-term interest rates have not yet peaked in the euro zone.

The markets continue to underestimate the potential for further rate rises. Any readjustment in expectations will fuel tensions in bond markets.

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[1] Lagarde Says Core Inflation in Euro Zone Is Still Elevated , Bloomberg, 23 October 2023

[2] ECB staff macroeconomic projections for the euro area , European Central Bank, 14 September 2023