The European Central Bank (ECB) could slow its interest rate hike campaign after inflationary pressures have started to ease in response to the central bank’s monetary policy tightening over the past year. The reported figures suggest a higher probability of increasing interest rates but at a slower pace.
It is expected that the ECB will raise interest rates by only 25 basis points to 3.75% in May from 3.5% in April, as seen below. A member of the European Central Bank's board, Isabel Schnabel, told POLITICO in April that the bank needs to see a ”sustained” decline in core prices before making the decision to change the course of the tightening policy.
The ECB emphasized that it is critical to rely on data when making decisions about policy rates due to the high level of uncertainty. These choices will be based on a number of variables, including the inflation outlook, financial and economic indicators, underlying inflation dynamics, and the efficiency of the transmission of monetary policy.
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Figure 1: ECB Rate April 2022-April 2024 based on Trading Economics
Tighter policy has so far shown its success in containing inflation. Core inflation in the Eurozone declined for the first time in 10 months in April to 5.6%. However, headline inflation rose to 7%, driven by increasing food and service prices.
The Bank Lending Survey (BLS) conducted by the European Central Bank showed that Euro area banks have reported a positive impact on their net interest margins during the first half of the year due to the ECB's key interest rate decisions. However, the impact on volumes has been negative due to weakening loan demand and deposit dynamics which has dampened bank profitability.
The survey also showed a negative impact on profitability via non-interest income, such as capital losses and net fee and commission income, as well as, higher provisioning needs and impairments reflecting higher credit risks which are expected to continue in the coming months. The impact of ECB interest rate decisions on European banks’ profitability is shown below.
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Figure 2: Net percentages of banks over the past six months and the next six months based on the European Central Bank (April 2023)
Investors are awaiting the bank’s decision which will likely affect European stocks and other important financial decisions. After the previous meeting where the bank increased rates by 50 bps, the Stoxx 600 closed higher.
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