Next ECB move hangs in the balance

Inflation in the Eurozone came in at 5.3% y/y in August, unchanged from a month earlier and slightly ahead of market expectations. On a monthly basis inflation picked up to 0.6%, more than reversing the prior month’s deflationary print. Core inflation dipped to 5.3% in August with the steady headline print a result of a 3.2% rise in energy prices month/month.

The CPI print for August on its own balances the outlook for the European Central Bank’s next decision on September 14. Flash PMI data for August were weak: the composite Eurozone-wide PMI fell to 47 from 48.6 a month earlier with a German manufacturing print of less than 40 weighing on overall regional activity. Germany’s economy barely emerged out of recession in Q2 2023 with the economy stagnating while France managed to perform much better with the economy rising by 0.5% q/q in Q2.

ECB president Christine Lagarde didn’t give a clear signal at the Jackson Hole symposium in late August whether the bank would hike once more or keep rates unchanged. Since then several ECB speakers have continued to indicate that inflation remains too high, with the August number still well above the ECB’s target level of 2%. Isabel Schnabel, an executive board member, said she saw “growth prospects being weaker” while inflation was “stubbornly high” and Pablo de Cos, head of Spain’s central bank, stressed the “importance of bringing inflation” back to target levels.

Market reaction to the inflation data has been dovish. EURUSD pulled lower from levels around 1.0940 to almost 1.0850 while German 2yr and 10yr yields have dropped. The probability of a hike at the September meeting has fallen to less than 25% as of August 31, compared with more than 30% around the Jackson Hole event, though one more hike between now and the end of the year has about a 60% likelihood priced in. Between now and September 14 major eurozone data will be limited to final prints of PMI and inflation numbers and investor sentiment surveys from Germany. The chances of a final rate hike to take the deposit facility rate to 4% look about 50:50 as of the end of August though we think the ECB will still push for one more by the end of 2023 to cement a disinflationary trend into place.