Eurozone Recession Won't Spook the ECB from Raising Interest Rates Again (and Maybe Again)

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The Eurozone has officially entered a technical recession, with negative growth recorded in both the fourth quarter of 2022 and the first quarter of 2023.

The latest data, which downgraded the first-quarter GDP to -0.1% quarter-on-quarter, comes just days before the European Central Bank's (ECB) policy meeting, where a 25 basis point interest rate hike is widely anticipated.

The ECB's guidance on future rate hikes will be crucial for financial markets and the Euro exchange rate complex.

Investors are eager to know if the ECB foresees further hikes in the future or if a pause is becoming more likely, particularly in the wake of the surprise downgrade that meant the economy has fallen into recession.

Ryan Djajasaputra, Economist at Investec, suggests that the ECB is likely to downplay the significance of the recession, given the impact of extremely volatile Irish GDP figures, which contracted by 4.6% on a quarterly basis.

Djajasaputra expects the upcoming meeting to result in another 25 basis point hike, bringing the key Deposit rate to 3.50%.

The Governing Council has already hinted at an additional hike next week and another planned move in July.

Despite the recession news, Eurozone inflation figures for the first quarter exceeded expectations, averaging 8.0% compared to the ECB's March forecast of 7.8%.

However, the latest figures for May provide some relief, as headline inflation has fallen to 6.1%, marking a 4.5% decrease from its peak in October 2022. Core inflation, excluding food, energy, alcohol, and tobacco, also dropped 0.3% on a monthly basis to 5.3%.

Djajasaputra suggests that while May's core inflation reading is positive news for the ECB, it is unlikely to alter the central bank's current thinking. The ECB would need to observe sustained downward momentum in core price pressures before considering any policy pause.

The ECB's decision on interest rates and the guidance provided during the policy meeting will have significant implications for financial markets and the future direction of the Euro.

Market participants will closely analyze the ECB's stance to gauge the central bank's confidence in the Eurozone's economic recovery and its commitment to managing inflationary pressures.