European Central Bank (ECB) Governing Council member Klaas Knot has suggested that the central bank’s campaign of interest-rate hikes may soon pause. Knot, who is traditionally hawkish, stated that while a rate hike in July is necessary, any further tightening beyond July is not guaranteed. He emphasized the need to carefully monitor data on the distribution of risks surrounding the baseline. These comments have led to a decrease in market expectations for two more quarter-point increases in the deposit rate. Government bonds have gained, and the euro has retreated against the dollar. Knot’s remarks have raised doubts about the previously anticipated terminal rate of 4% after the June meeting, with analysts suggesting a terminal rate of 3.75% is a real possibility.
The recent decline in inflation has boosted confidence that the global economy can withstand rate hikes without significant damage. Bank of America’s survey of fund managers found that the receding inflation narrative is driving market sentiment. Investors are hopeful that US rates will decrease sooner and that China will implement a stimulus package to boost consumption. However, concerns remain about China’s stuttering recovery and its potential impact on global growth.
The ECB’s upcoming policy announcement may provide further clues about the direction of borrowing costs. While some members of the Governing Council believe that rate hikes should continue into the autumn to address underlying inflation, others are concerned about the eurozone’s fragile economy, which is struggling to emerge from recession. The situation is similar in the US, where the Federal Reserve is expected to raise rates next week, but future moves are uncertain. In contrast, the Bank of England faces a clearer task due to inflation exceeding estimates, with markets even anticipating a 50 basis-point rate increase at the next meeting in August.
Bank of Italy governor Ignazio Visco, a more dovish voice within the ECB, also spoke to Bloomberg in India and suggested that price gains may decrease more quickly than the ECB’s current projections. Knot dismissed the view that inflation may reach the 2% target in 2024, rather than 2025, as “optimistic”.
Overall, Knot’s comments have introduced uncertainty about the future path of interest rates, challenging previous expectations of further rate hikes. The ECB’s policy announcement and upcoming inflation reports will provide further insight into the central bank’s decision-making process.