The ECB raised rates by a half a percentage point on Thursday and promised a similar move for March but markets still pared rate hike expectations, taking its lack of guidance for subsequent steps as a wavering in its commitment.
Wunsch said markets got the wrong end of the stick because Thursday was a “hawkish decision” and the ECB is likely to keep going, hiking in May and possibly thereafter, depending on how inflation develops.
“I don’t think we’re going to move from 50 basis points (in March) to zero,” Wunsch told Reuters. “It might be another 50 basis points or we might be moving to 25. I will certainly not exclude another 50 basis points but that’s going to be dependent on the data.”
The key determining factor in how high the 2.5% deposit rate will go is the stickiness in core inflation, which has held above 5% in recent months, well above the ECB’s 2% target.
“If core remains persistent, if we keep seeing core momentum being close to 5%, for me a terminal rate of 3.5% would be a minimum,” Wunsch said. “But I don’t want to give any number that is not conditional on incoming data.”
Markets currently price the terminal rate at 3.35% by July.
But even 3.5% may not be enough and the euro zone should look at rate moves by the United States and the UK if the ECB fails to break the momentum in underlying inflation.
“Rates are clearly above 4% in the UK and the U.S.; that would also be a reference for me,” Wunsch said. “Why would we stay at 3% if we have more or less similar core numbers?
The Bank of England raised rates to 4% on Thursday while the Federal Reserve lifted its own benchmark to a range of 4.5% to 4.75%
“I’m not saying we need to go to 4%… but if incoming data continue to show very persistent core, we will have to look at what the U.S. and UK seem to consider as a restrictive enough interest rates to bring inflation back to 2%.”
The problem is that labour markets are very tight and real wages have fallen sharply, so plenty of wage catch up is still likely and that is bound to keep core inflation under pressure, Wunsch added.
Source: Economy - investing.com
