ECB to hike deposit rate 25 bps in July, ditch negative rates by end-Sept- Reuters poll

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FILE PHOTO: European Central Bank (ECB) headquarters building is seen in Frankfurt

By Swathi Nair

BENGALURU (Reuters) - The European Central Bank is expected to raise the deposit rate for the first time in over a decade in July and bring it out of negative territory at its following meeting in September, despite a 30% chance of recession within a year, a Reuters poll of economists showed.

With inflation hitting a multi-decade high of 7.5% in April and almost every other major central bank having already raised interest rates, ECB President Christine Lagarde backed calls for an early rate hike by policymakers last week.

The bank is now expected to end its bond purchases programme in July and follow that with a 25 basis-point deposit rate hike a few weeks later, according to a majority of economists polled from May 10 to 16.

Until recently, forecasters were expecting the ECB to wait until the final quarter of the year to raise the deposit rate, currently at -0.50%.

Of the 46 of 48 economists who expect the deposit rate to rise in the third quarter, 26 said rates would rise by 50 basis points by the end of the period, implying quarter-point moves at both the July and September meetings.

Another 18 respondents said the deposit rate would only rise 25 basis points in Q3 and two said it would only climb 10 basis points to -0.40% by the end of the quarter.

An even clearer majority expect rates to no longer be negative by the end of the year. About 90% of economists, or 43 of 48, said the deposit rate would be 0% or higher by then, with 44%, or 21 of 48, saying it would be at 0.25% by then and 8%, or 4 of 48, saying it would be at 0.50%.

"There is widespread support for ending negative interest rate policy at the ECB, but they will take a very cautious approach to policy normalisation, in light of substantial macro uncertainty and concerns about a growth slowdown," said Jens Eisenschmidt, chief European economist at Morgan Stanley.

"This will be the first time in over a decade that the ECB is lifting rates – with no support from asset purchases – so taking smaller steps would allow the ECB to observe the reaction in markets, with a possible fragmentation of financing conditions in the euro area likely a key concern".

The latest poll results are still lagging rate futures, which are pricing in a cumulative 90 basis points of rate increases for the rest of the year or between three and four 25 basis-point moves.

Even that would leave the ECB well behind the U.S. Federal Reserve, which is currently expected to have its federal funds rate around 2.00-2.25% by the end of this year. [ECILT/US]

However, the poll also found the time window to raise rates is closing for the ECB, with a steady median 30% probability of a recession in the next 12 months, as the war in Ukraine pushes energy prices higher and saps consumer spending power.

The bloc's economy was expected to grow 0.3%, 0.5% and 0.6%, in the second, third and fourth quarters. This is a downgrade from 0.4%, 0.6% and 0.6% predicted last month.

On an annual basis, it was expected to grow 2.7% this year, down from 2.9% and 2.3% next, the same as predicted last month.

The European Commission cut its growth forecast for the euro zone this year to 2.7% from 4.0% projected in February, and upgraded its inflation forecasts to 6.0% this year from 3.5%.

Rising inflationary pressures, driven by a persistent surge in food and energy prices, have deepened the cost of living crisis in the euro zone.

Prices are set to rise 7.7% this quarter, over three times the ECB's 2.0% target and higher than the 7.3% prediction given last month. It will ease gradually over coming quarters but medians did not show it at target through next year, the forecast horizon.

Asked what impact the cost of living crisis would have on growth, 19 of 25 economists said it would be severe and two said very severe. Only four said it would be mild.

It will be over six months before the crisis eases significantly according to 90% of the respondents to another question.

Despite recession risks, unemployment in the single currency bloc is expected to remain near record low levels at 6.9% and 6.8% this year and next.

Meanwhile, average wage growth was expected to be 3.0% this year, the poll median showed.

"While current dynamics are triggering higher wage demands, companies are still being cautious due to the weakening outlook," said Bas van Geffen of Rabobank.

"Anecdotal evidence is therefore also pointing to shorter wage agreements so that there's flexibility to adjust next year, either higher or lower, depending on inflation. So, so far it still seems to be mostly catch-up wage growth rather than forward-looking".

(For other stories from the Reuters global economic poll:)

(Reporting by Swathi Nair; Polling by Sarupya Ganguly and Milounee Purohit; Editing by Hugh Lawson)

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