Money management executives warned that the European Central Bank is in "policy mistake territory" amid continued interest-rate hikes — albeit at what is expected to be a slower pace.
The ECB's governing council increased the European Union's key interest rates by 25 basis points on Thursday. Effective May 10, the interest rate on the main refinancing operations will increase to 3.75%, the rate on the marginal lending facility will increase to 4%, and the rate on the deposit facility will increase to 3.25%.
The 25-basis-point increase was made "in light of the ongoing high inflation pressures," Christine Lagarde, ECB president, said in a news conference. Eurostat estimates inflation was 7% in April, up slightly from 6.9% in March.
The latest hike was the smallest since the start of the ECB's hiking cycle in July, noted Anna Stupnytska, global macro economist at Fidelity International, in an emailed comment.
However, Ms. Stupnytska warned that the ECB's policy tightening to date "is already sufficient to cause a recession. The effect of tighter policy is becoming more obvious in the U.S., with the Fed signaling a potential pause at its May meeting, largely because the Fed started its hiking cycle four months ahead of the ECB. Given lags in the transmission mechanism, the euro area real economy is yet to face the hit," she said.
She said that tight credit conditions are "here to stay" even without further stress in the European banking system, "ultimately leading to credit contraction and recession… We continue to stress that the ECB is very likely already in the policy mistake territory that would ultimately require a rapid course correction in coming months."
Hussain Mehdi, macro and investment strategist at HSBC Asset Management, said that despite a stabilization of core inflation — albeit high inflation — and indications of a "significant economic slowdown later this year," the ECB's worries about the passthrough of headline inflation into wage growth means further hikes are possible through the summer.
"Recent signs of softening activity, such as the weak Q1 GDP print, imply the risk of overtightening and a potential policy error," he said in an emailed comment. "Overall, downside macro risks amid optimistic market pricing means we continue to advocate a defensive asset allocation, which includes an underweight view on European equities. Our macro view is consistent with a preference for short-duration fixed income assets, especially U.S. Treasuries," he said.
