The European Central Bank is preparing to slow down interest rate hikes as financial conditions tighten

FRANKFURT – The European Central Bank is expected to raise its benchmark interest rate by a smaller 25 basis point step on Thursday, as core inflation eases and eases. Private survey data points to tougher financial conditions in the region.

The new economic numbers reinforce the ECB’s argument for only raising interest rates by a smaller amount at the policy meeting, possibly announcing an increased pace of its balance sheet reduction.

Quantitative tightening, or QT, has already taken place as the European Central Bank shrinks its portfolio of giant bonds on its balance sheet after years of government debt-buying and monetary stimulus. The European Central Bank has kept rates at zero and below for years, launching bond-buying programs such as the APP (Asset Purchase Program) and PEPP (Pandemic Emergency Purchase Program) in an effort to emulate lending.

The APP started in the middle of 2014 to deal with the ever-low levels of inflation. It was frozen between January and October 2019 and then until July 2022 – but it continued to reinvest payments from assets that fell due. PEPP, on the other hand, was a more flexible bond purchase program introduced during the coronavirus pandemic.

Deutsche Bank said: “To prevent financial conditions from overreacting downward to a +25bp velocity, we expect the ECB to announce a faster QT: an increase in the initiation of APP reinvestments from €15 billion per month to €20 billion per month.” of the third quarter. Chief Economist and Controller of the European Central Bank, Mark Wall, in a note to clients.

Eurozone inflation rose slightly to 7% in April, according to new data released this week, but core inflation – which excludes food, fuel, tobacco and alcohol – slowed to 5.6% from 5.7%, its first decline since last June and lower than it was. the market expects.

“The inflation trend is declining, as the big push from higher food prices fades,” said Joerg Kramer, chief economist at Commerzbank, in a research note.

“It’s a positive sign that core inflation has fallen for the first time in a long time. But because of wage adjustments above 5 percent, inflation pressure should remain stubbornly high.”

In addition, the European Central Bank’s bank lending survey indicated an exceptionally large drop in credit demand amid tightening lending standards, adding to the case for a lower interest rate hike.

A net 38% of banks in the 20 sharing countries saw a decline in demand for credit from businesses in the first three months of this year. This was the largest net decline since the global financial crisis of 2008-2009.

While the Eurozone avoided recession in the first quarter with a weak growth of 0.1%, the effects of the monetary tightening cycle are showing the first signs of it dampening demand. Traditionally, monetary policy has a time lag of about a year, and the ECB only started the strolling cycle in June 2022.

“After May, we expect another rate hike of 25 basis points in June,” Cramer said.

“Then the ECB should stop raising interest rates and will watch the effects of its tighter monetary policy on the real economy.”

—CNBC’s Silvia Amaro contributed to this article.