The European Central Bank is anticipated to reaffirm its decision to hike interest rates next month, as policymakers gather in Amsterdam for their first meeting outside of Frankfurt since the coronavirus outbreak began.

While inflation in the 19-member eurozone reached a new high in May, a rate hike would not occur until July since the ECB must first formally terminate its net asset purchases, according to its forward guidance.

The crucial question is how rapid the shift will be in the coming months; some analysts are predicting a greater boost in September at the least.

“A handful of Governing Council members are already open to a 50bp hike,” said Mark Wall, a chief economist with Deutsche Bank, in a research note.

“We believe the ECB is continuing to underestimate inflation and we expect support for a 50bp hike will increase as the summer progresses.”

The ECB will also provide revised staff predictions for GDP and inflation this week, and market players will be watching the 2024 inflation print attentively because it represents the ECB’s medium-term price target.

The ECB is also expected to lower its growth estimates while raising its inflation expectations, with 2024 inflation likely to reach the ECB’s medium-term target of 2 per cent.

The ECB’s Governing Council is most concerned about persistently high inflation.

“Inflation is not only too high, but also too broad,” Francois Villeroy de Galhau, France’s central bank governor, said last week at a conference in Paris. “This requires a normalization of monetary policy — I say normalization and not tightening.”

While the ECB’s primary purpose is to combat inflation, the topic of fragmentation risk will almost certainly be discussed this week as well.

Bond markets have already reacted to the halt of asset purchases, reassessing the various risks associated with various eurozone countries.

As a result, the yield differential between German and Italian bonds has widened. On Monday, the 10-year spread was above 200 basis points, up from less than 140 basis points at the start of the year.

“Fragmentation makes life complicated for the ECB. This is not to say that these considerations will overrule whatever the inflation picture dictates in terms of policy tightening,” Dirk Schumacher, an ECB watcher with Natixis, said in a research note.

“But it is nevertheless an important implicit argument for gradualism,” he added.

(Adapted from Reuters.com)

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