ECB to remain on hold in April amid second-round inflation concerns

Facing the new round of energy price shocks triggered by the situation in the Middle East, the European Central Bank is showing strong policy resolution. The market generally expects that at the monetary policy meeting this Thursday (April 30), the European Central Bank will keep the policy interest rate unchanged and is expected to unanimously pass a prudent signal to the outside world that "buying time for space" is necessary.

The suspense of interest rate hikes is postponed to mid-year

Despite the lingering shadow of inflation, the Governing Council of the European Central Bank has been highly unified in recent steps, with several officials publicly and clearly opposing an increase in April, emphasizing the need for more economic data support. However, the game between institutions over subsequent paths is intensifying.

JPMorgan Chase and Barclays both say that attention is generally focused on June and September. JPMorgan Chase predicts that it will raise interest rates by 25bp respectively; Barclays believes that this meeting will maintain maximum policy flexibility and is not in a hurry to release a clear signal.

Nomura Securities has given a more challenging assumption. If Brent crude continues to stabilize at above $95 a barrel before June, the ECB will be forced to start two interest rate hikes before the third quarter.

The "aftershocks" of the energy crisis and the "hedge" of weak demand

The turmoil in Iran has been transmitted to the economic data of the eurozone. Fluctuations in fuel prices have raised HICP inflation readings, and investor sentiment has deteriorated. But the European Central Bank believes internally that the current fluctuations are far less than the 2022 energy crisis.

European Central Bank President Lagarde pointed out that there is an essential difference between the current economic context and 2022, with weak momentum of demand growth. Weak domestic demand is becoming a "natural hedge tool" against inflation. However, the trend contraction of global crude oil and liquefied natural gas (LNG) supply makes it difficult for supply-side pressure to dissipate as quickly as in the past.

Inflation expectations and the "second-round effect"

比起原材料价格的波动，欧央行目前更担心的是通胀的“第二轮效应”，即物价上涨引发工资上涨，进而形成恶性通胀螺旋。

Compared to fluctuations in raw material prices, the ECB is currently more concerned about the "second-round effect" of inflation, that is, price increases leading to wage increases, which in turn form a vicious inflationary spiral.

The latest released inflation expectations of businesses and consumers have both increased sharply, with businesses increasing from 2.6% to 3.0% for one year, and consumers increasing from 2.5% to 4.0% for one year, indicating that inflation expectations are spreading to a wider range of economic entities.

This means that the Middle East war and the rise in energy prices are not only inflation shocks but also stagflation shocks, which add complexity to the ECB meeting this Thursday.

No longer acting "instinctively," scenario analysis sets the tone

Lagarde publicly reiterated that the European Central Bank will neither repeat the mistake of being slow to deal with inflation in 2022 nor have an "instinctive reaction" in the face of pressure.

At present, the market pricing has already digested an expectation of a cumulative 60bp interest rate increase by the end of 2026. Another highlight of this Monetary Policy Meeting is the update of the scenario analysis. If the new model shows that HICP inflation can steadily return to the 2.0% target at the end of the forecast period, the market's current radical interest rate hike expectations could be revised downward.