ECB fans talk of September pause after raising rates to 23-year high By Reuters

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) -The European Central Bank raised interest rates for the ninth consecutive time on Thursday but dialled up the possibility of a pause next month as stubbornly high inflation and recession worries pull policymakers in opposing directions.

Fighting off a historic surge in prices, the ECB has now lifted borrowing costs by a combined 425 basis points since last July, worried that price growth could be perpetuated by both rising costs and wages in an exceptionally tight jobs market.

With Thursday’s 25 basis point move, the ECB’s deposit rate stands at 3.75%, its highest level since 2000, before euro banknotes and coins were even in circulation. The main refinancing rate was set at 4.25%.

ECB President Christine Lagarde said what comes next was in the balance, although the central bank was determined to “break the back” of inflation. It was widely criticised for a slow response to last year’s initial surge in prices.

She had responded to most of the questions at a press conference by stressing that all options remained on the table but sent the euro tumbling with a dovish flourish near the end.

“Do we have more ground to cover? At this point in time I wouldn’t say so,” Lagarde said, almost unprompted.

“Because as I said, the data that we just discussed, and the assessment of (incoming) data will actually tell us whether and how much ground we have to cover in September and at subsequent meetings.”

The ECB’s full policy statement had said interest rates would be set at “sufficiently restrictive levels for as long as necessary” for a timely return of inflation to its 2% target.

But it dropped a reference to rates having to be “brought” to a level that cuts inflation quickly enough, a nuance that could be seen as signalling further increases are not a given.

Lagarde explained the tweak was “not random or irrelevant”.

“There is the possibility of a hike (next time). There is the possibility of a pause. It’s a decisive maybe,” she said, adding that policymakers were both “open-minded” and unified.

That the ECB’s fastest-ever tightening spree is nearing an end is clear, with policymakers debating whether one more small move is needed before rates are kept steady for what some of them think will be a long time.

The problem is that inflation is coming down slowly and could take until 2025 to fall back to 2%, as a price surge initially driven by energy has seeped into the broader economy via large mark-ups and is fuelling the cost of services.

While overall inflation is now just half its October peak, harder-to-break underlying price growth is hovering near historic highs and may have even accelerated this month.

Lagarde said the risks of so-called “second round” effects had not worsened since last month. The labour market remains exceptionally tight, however, with record-low unemployment raising the risk that wages jump as workers use their increased bargaining power to recoup real incomes lost to inflation.

That is why many investors and analysts had been looking for the ECB to pull the trigger again in September and stop only if autumn wage data delivers relief.

“My overall sense is that everyone expected Lagarde to stress that the bank was data-dependent, and a little bit more hawkish (than the Fed) as is the ECB’s style,” Societe Generale (OTC:)’s FX strategist Kit Juckes said.

“But what was striking, was she has basically come out and said the net result of all the recent data was that it was not good.”

RECESSION?

But the mood is clearly changing as the economy of the 20-country euro zone slows. While markets had fully priced in another rate hike just a few weeks ago, a growing number of investors are betting that Thursday’s move will be the last.

The euro tumbled during the Lagarde’s press conference and briefly dipped under $1.10 in the aftermath, having been up as much as 0.5% at $1.1149 beforehand.

More rate tightening would however be consistent with comments from a host of policymakers, including ECB board member Isabel Schnabel, that raising rates too far would still be less costly than not lifting them high enough.

On Wednesday, the U.S. Federal Reserve raised borrowing costs and kept the door open to further tightening, though Fed Chair Jerome Powell gave few hints about September, a stance the ECB is likely to copy.

Indicators of business, investor and consumer sentiment and bank lending surveys point to a continued deterioration after the euro zone skirted a recession last winter.

And with manufacturing in a deep recession and a previously resilient services sector showing signs of softening despite what is likely to be a superb summer holiday season, it is hard to see where any rebound would come from.

Such weakness, exacerbated by a loss of purchasing power after inflation eroded real incomes, could push down price pressures faster than some expect, leaving less work for the central bank to do.

This is a key reason why the balance of expectations has started to shift away from another rate hike, with economists increasingly focusing on how long rates will stay high.

“We know we are getting closer,” Lagarde said, referring the end of the ECB’s rate hike run.

(Additional writing by Marc Jones in London; Editing by Catherine Evans)