It has certainly been a busy eighteen months for the Monetary Policy Committee of the European Central Bank.
Having spent several years repeating pretty much the same script, meeting after meeting, about leaving rates unchanged at their historically low levels, the inflationary backdrop prompted a change in course last year.
And it was a course that the committee took to with some gusto.
Not even the prospect of a banking crisis on the continent was enough to knock Christine Lagarde and her team off their rate hiking path.
For ten meetings in a row from July of last year, tackling inflation was the mantra and a hike in interest rates was delivered at each meeting to accompany that message.
This week, the ECB decided to call a halt to the cycle of rate hikes – for now.
So, what lies ahead for rates and could the bank even be facing the prospect of cutting interest rates sooner rather than later?
Late to the game
The current inflationary surge kicked off in earnest around the middle of 2021.
The reawakening of global supply chains in the aftermath of the lifting of pandemic restrictions was met with a surge in demand from consumers who were keen to get back to life as they knew it, bolstered in some cases by savings built up during successive lockdowns.
By the end of the year, the Bank of England became the first of the major Central Banks to raise interest rates followed some months later by the US Federal Reserve.
Arguments around the inflationary surge being ‘transitory’ came to a full stop when Russia invaded Ukraine in February 2022 sending oil and gas prices soaring.
However, the ECB continued to adopt a ‘wait and see’ approach and embraced rate increases quite late in the day by the standards of its counterparts.
It finally took to the rate hiking path with quite a statement in July of last year.
One swift move
Given the careful nature of the ECB’s initial approach to rate increases, it had been widely anticipated that it would start out gently.
A rate hike of a quarter of a percentage point – or 25 basis points – was widely expected in July 2022, bringing the borrowing rate from zero to 0.25% and the deposit rate, which had been negative for several years, to minus 0.25%.
Instead, it opted for a hike of a full half a percent bringing the deposit rate back to zero in one swift move.
The language Christine Lagarde used on the day had taken a decidedly hawkish turn together with the decision to abandon ‘forward guidance’ on rate hikes.
Decisions on rates, Ms Lagarde said, would be taken on a month-by-month basis and would be dependent on the data.
The July hike was followed by an unprecedented 75 basis points increase in September.
Even the most dovish of commentators agreed that the hikes – despite being late in coming – were warranted.
ECB President Christine Lagarde
As 2023 came around and a milder-than-expected winter confounded the worst predictions of the inflation doom-mongers, opinion began to diverge around the future direction of rates.
The so-called ‘doves’ reverted to their line that rate hikes should be given time to bed in and the ECB should adopt a ‘wait-and-see’ approach.
The hawks had other ideas. Inflation needed to be tamed and it couldn’t be done in a piecemeal fashion, they argued.
The latter argument appeared to prevail. Not even the collapse of US lender, Silicon Valley Bank – as well as other smaller US banks – and warnings about the prospect of ‘contagion’ in the wider banking sector was enough to prompt the ECB into pausing its rate hiking cycle in March of this year.
The bank pressed ahead with a 50 basis point hike.
“Inflation is projected to remain too high for too long,” Christine Lagarde said as she kicked off the March press conference, doubling down on the bank’s mission to tackle inflation.
The decision was followed that weekend by the takeover of Swiss lender Credit Suisse by its rival, UBS.
More gradual increases
The March half point increase was followed by a series of quarter point hikes up until last month.
Euro zone inflation – which had peaked in October 2022 at a rate of 10.6% – has been falling steadily.
The rate stood at 4.3% in September, according to the latest figures, which is still more than twice the ECB’s target of 2% inflation.
“Inflation is still expected to stay too high for too long, and domestic price pressures remain strong,” Ms Lagarde said this week as the bank paused its hiking cycle.
‘Higher for longer’
If ‘transitory inflation’ was the buzz phrase around the start of 2022, today it has been replaced with ‘higher for longer’ – the reference to rates remaining elevated for a more prolonged period that might have been expected previously.
But much like the ‘transitory’ argument, the ‘higher for longer’ camp has its detractors.
Some analysts believe that the ECB will be forced into cutting interest rates sooner rather than later, mainly on the back of weakness in member economies, particularly the bloc’s biggest constituent, Germany.
“It is clear that inflation will continue to drop as the economy will remain weak for the rest of the year,” Edward Moya, Senior Market Analyst with OANDA said.
“After ten rate hikes, the ECB is likely done raising rates, but they won’t say they are done hiking. It will take time for them to get inflation to 2%, but it should happen next year as policy is restrictive enough,” he said.
His colleague went even further, saying the path towards rate cuts would become more apparent in the months ahead.
“It all comes down to the data between now and the December meeting at which point we may get forecasts that enable the ECB to at least discuss when rate cuts could be appropriate,” OANDA’s Craig Erlam said.
“That may seem unlikely now but the economy is clearly struggling and so it’s only a matter of time,” he added.
The consensus generally is for rate cuts in the second half of next year with the deposit rate falling to 3.5% by end-September.
Christine Lagarde said it was too early for talk of rate cuts at this time, adding that there hadn’t been any conversation on the matter at the meeting on Thursday.
“Even having a discussion on cuts is totally, totally premature,” she said.
“The fact that we are holding doesn’t mean that we will never hike again,” she added.
Hawks on the alert
Indeed, the hawks have not returned to nest just yet.
The prospect of more rate hikes down the track cannot be definitively ruled out at this stage.
Energy markets have been considerably volatile of late.
It started with gas prices which spiked following strike action at liquefied natural gas plants in Australia.
They have since settled back after a resolution of the pay dispute was agreed but that was quickly followed by price surges on oil markets on foot of a decision by Saudi Arabia to cut production.
As oil prices moderated, hostilities in the Middle East broke out, sending prices soaring once again.
The price of a barrel of Brent crude looks to be settling at a relatively expensive $90 a barrel.
It coincides with recent data demonstrating some considerably ‘sticky’ inflation in some parts of the world.
Although inflation here fell back to 3.6% in October, according to the latest CSO ‘flash’ estimate on Friday, another surge in inflation could be ruled out at this point and neither could another rise in interest rates.
Hence Christine Lagarde’s reticence around committing to anything at this point.
Reprieve for mortgage holders?
After ten successive hikes, mortgage holders will at least be relieved at the decision by the ECB to hold steady for now.
For tracker mortgage holders, who have endured each and every rate hike since July of last year, the relief will be particularly acute.
While some will argue that they had it good for many years while rates were at rock bottom, tracker holders have endured sharp increases in borrowing costs in the last year and a half.
In some cases, they will be able to avail of the mortgage interest relief measures announced in the Budget.
While variable rate mortgages have remained largely unchanged, they have started to nudge upwards with Bank of Ireland the latest to announce a hike in its variable rate offering in recent days.
For those coming off a fixed rate period, they will be hoping that a drop in interest rates will come about before that happens.
However, as Trevor Grant, Chairperson of the Association of Irish Mortgage Advisers points out, a drop at the ECB level is no guarantee of a fall at the retail bank level.
“Even if the ECB starts to reduce its rates at some point next year, home-loan mortgage rates are highly unlikely to fall because home loan rates have not increased at the same levels as the ECB rate has, and furthermore, the banks are under pressure to increase returns for savers,” he explained.
While a pause in rate hikes is a step in the right direction for beleaguered borrowers, the rates environment looks like it could remain somewhat elevated for some time to come.