Financing Conditions in the Euro Area: Deposit Interest Rate at 4 Percent This Autumn?

At the next meeting of the European Central Bank 27. July, the Croatian Employers’ Association expects a further increase in the deposit rate by 25 basis points to 3.75 percent in line with the high level of core inflation. This could easily be the last rate hike, given the decline in producer prices, the expected easing of core inflation, and the growing likelihood of a recession in the euro area in the second half of the year.

In the absence of excessive volatility in global financial markets, the ECB could potentially raise the rate by another 25 basis points in September and then maintain it at four percent as long as core inflation remains significantly above the target level of two percent, due to the relatively strong growth in employee earnings, according to HUP.

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Additionally, the ECB will further accelerate the pace of balance sheet reduction in July by no longer reinvesting bonds upon maturity. This corresponds to an average balance sheet reduction of 25 billion euros per month, which frees up space for the rise in long-term interest rates and increases the risk of shocks and fragmentation in the bond markets or additional pressure on the cost of government financing.

In the baseline scenario of ‘shallow’ recession, the ECB remains ‘reactive’ in maintaining the restrictiveness of monetary policy until signs of stabilization of inflation near the target level of around two percent are observed. This implies that the ECB, despite the impending recession, will not cut reference interest rates at least until spring 2024, concludes HUP.

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photo Focus Economics

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