MFS: Possible ECB interest rate hike in September not yet fully priced in

MFS: Possible ECB interest rate hike in September not yet fully priced in

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Peter Goves, Global Head DM Fixed Income Rates Strategy Research at MFS, looks ahead to this week's ECB meeting:

'We expect no change in ECB policy rates when the Governing Council meets this week. Since its last meeting, the central bank has continued to stress the data dependency approach. The June updated projections showed a small upward revision in the inflation forecast for both 2024 and 2025 (now at 2.5% and 2.2% from 2.3% and 2%) and Lagarde has stressed the need to analyze a whole range of data to achieve more clarity on the inflation outlook.

Residual inflation stickiness in services, wage data and ECB rhetoric means a hold is more likely than not this week. Overall, we still see growth as generally below potential and look for wage data and domestic inflation to fall. We continue to pencil two more 25bp cuts this year.

Our view remains that the modest growth outlook and falling inflation will mean cuts remain on the table. We expect upcoming inflation data and new projections in September to validate a cut at that meeting. Rates will still remain restrictive at 3.50% by September, with more scope to cut towards neutral in late 2024 and 2025. Risks around more stickiness in services inflation could move the needle towards an even more cautious approach by some Governing Council members.

Given the mixed data and ECB rhetoric, it is entirely understandable that the market places a near zero chance of any move in policy this week. September isn’t fully priced which leaves some further scope for a rally on a 25bp cut delivered at that meeting. This keeps us constructive on euro area duration over the near and medium term.

ECB spreads remain relatively contained given the French event risk (that proved relatively short lived and more idiosyncratic than systemic). We see this as a potential item to come up in the press conference, but we doubt Lagarde will veer into opinions on the domestic French political situation. Furthermore, Lagarde will likely affirm that transmission of monetary policy has worked well.'