Markets are currently pricing in a 68% chance that the ECB raises interest rates by 25bps tomorrow, according to data from Bloomberg.
At the start of the month, traders had only priced in a 20% chance of a hike, but reports that the ECB expected inflation to stay above 3% in 2024 this week have strengthened sentiment that more tightening was necessary.
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After switching its rate setting approach to be data dependent earlier this year, ECB president Christine Lagarde said in July that the central bank was no longer "in the domain of forward guidance" and policy would be set to "ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary".
Russell Silberston, investment strategist at Ninety One, said the ECB had been "spoilt" in recent months by reliance on forward guidance, but were now struggling to predict a path forward for the central bank.
Meanwhile, Franck Dixmier, global CIO for fixed income at AllianzGI, noted the ECB was "no longer on autopilot", instead relying heavily on recent releases of data.
Split views
Some analysts have said tomorrow's decision will be a close call, as Shaan Raithatha, senior economist at Vanguard, Europe, argued that while the central bank should adopt a final 25bps hike, a "sharp deterioration in economic activity" meant that a pause would not come as a surprise.
Europe's Purchasing Managers' Index, a measure of economic trends in the manufacturing and service sectors, came in at 43.5 in August, the 14th consecutive month of readings below 50.
Meanwhile, the continent's August services PMI sat at 47.9, its lowest in 2023 and down from 50.9 in July.
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Raithatha also pointed to a deterioration in credit conditions and a sharp rise in corporate interest payments as key signs that the ECB will downgrade its 2023 growth forecast tomorrow from 0.9% to closer to the firm's 0.5% call.
AllianzGI's Dixmier was also anticipating a 25bps hike from the ECB, as he argued that despite a slowdown in the economy, underlying inflation in the continent remains "too high". He also expected inflation forecasts to continue to be revised upwards by the ECB, partially due to the recent rise in oil prices.
The "frustratingly sticky" core inflation, which remained unchanged in August from the start of the year at 5.3%, was also the largest concern for Raithatha.
On the other hand, Jason Davis, global rates portfolio manager at JP Morgan Asset Management, took the opposite view. He said the ECB was likely to pause hiking tomorrow, instead using the meeting to indicate they are willing to hike again in October if required.
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"If, however, the ECB does decide to hike tomorrow, they are more likely to indicate a willingness to pause thereafter keeping the impact on the terminal rate fairly limited," he added.
Peter Goves, head of developed market debt sovereign research at MFS Investment Management, said rates would remain steady but be joined by a signal that the tightening cycle "has not necessarily come to an end".
"New staff projections will almost certainly have to include a weaker growth profile," Goves added, arguing that the ECB's current interest rates of 3.75% "could well be the terminal rate".
There is also the possibility of a "hawkish hold", noted Raithatha, in which a pause in rate hikes is the "compromise made for a more aggressive path of balance sheet contraction" in the coming months.