Markets
The ECB as expected raised the policy rate by 25 bps to 2.25% today. It said the war in the Middle East is generating inflation pressures, making the case for a hike “across a range of scenarios”. The central bank stayed vague on future moves. It remains well positioned to navigate the uncertainty and will follow a data-dependent and meeting-by-meeting approach. Updated forecasts, however, suggests at least one more increase is in the making. Headline inflation was jacked up to 3%-2.3%-2% in 2026-2028 from 2.6%-2%-2.1% in March. Higher energy prices are expected to feed into food, goods and services inflation to some extent, prompting a significant bump in core inflation forecasts (2.5%-2.5%-2.2%) as well, to be well above 2% across the policy horizon. GDP forecasts were marginally revised down for this (0.8%) and next (1.2%) year, reflecting a more pronounced impact of the war on commodity markets, real incomes and confidence. 2028 was lifted to 1.5%. Inflation risks are tilted to the upside (energy prices, spillovers to wages and other prices, fragmented supply chains, raw material constraints …), those for growth to the downside (prolonged conflict, higher energy prices for longer, trade frictions, supply chain disruptions …). The full implications of the conflict ultimately depend on the intensity and duration of the energy shock as well as the scale of its indirect and second-round effects.
ECB chair Lagarde in the Q&A said the decision was unanimous with no alternative proposals (eg. bigger hike or status quo) discussed. She deflected a question on what to expect for next month or later this year. But she went into length to disregard the notion that today’s hike should be not at all be considered an insurance move. Instead the ECB is seeing and therefore reacting to the initial energy shock broadening. Lagarde added that they have developed a “milder” scenario next to the adverse and severe one relative to the base scenario. It’s unlikely to materialize, she said, but even in that case today’s hike was seen as appropriate. The ECB president didn’t say which of the scenarios is applicable today but referred to her March speech in which she outlined the reaction function of the central bank in three possible cases. Of those three, she dismissed the “see-through-the-shock” one. The second case – a large though not too persistent inflation overshoot which requires a measured policy adjustment – appears to be the dominant one instead. She sounded not too worried on growth. “It’s not as if we are in an environment where growth is absent or under significant threat.” With that, the door remains wide open for a further “measured adjustment”. Money markets are raising bets for back-to-back action in July with a hike currently discounted for +/- 65%. The broader market reaction was muddied by Donald J. Trump though. In a pre-presser message on social media, he said that the US will hit Iran very hard tonight. He threatened to “assume total control of” Iran’s oil and gas markets by taking Kharg Island, Iran’s oil export artery, “at some point”. Oil prices jumped up from intraday lows around $92 to $94, core bond yields erased earlier losses and the euro fell against the US dollar. All of that reversed meanwhile, suggesting markets aren’t buying into Trump’s threat. That could backfire.
News & Views
In the Norges Bank’s (NB) Q2 Regional Network Survey, contacts revised down growth prospects for the current quarter from 0.4% to 0.2%, but see growth picking up in Q3 (to 0.3%). All sectors (except oil services) expect higher activity ahead, even as customers become more hesitant. Investment in defence and emergency preparedness is boosting activity in commercial services. Activity in the construction sector stays weak. Slightly fewer contacts report capacity constraints and the share facing recruitment difficulties has declined somewhat. 30% of respondents report full capacity utilization. This indictor gradually eased to the lowest level since 2020. Recruitment difficulties have also eased for the likes of IT-expertise. Difficulties to recruiting several other skilled workers remain in place. Even so, estimated wage growth for this and next year is upwardly revised from 4.2% and 3.9% respectively in the Q1 survey to 4.5% and 4.1%. NOK 2-y swap yield declines 5 bps. Markets see <20% chance of a 25 bps hike next week. September is 90% discounted. The krone eases slightly further to EUR/NOK 10.99.
