Exclusive: 50-bp Rate Hike Not ECB Baseline for Now, But Council Will Have to Discuss
21 April 2022
By David Barwick – FRANKFURT (Econostream) – As the debate about rates lift-off by the European Central Bank enters a phase of greater urgency, the date of a first hike is not the only issue about which ECB Governing Council members will have to come to consensus.
Econostream understands that questions regarding the size of the initial increase in official borrowing costs and, related to that, the appropriate spread between the ECB’s key interest rates are going to be subjects of monetary authorities’ attention.
So far, Governing Council members, to the limited extent they have positioned themselves on the subject, have publicly indicated an expectation of rate hikes on the order of 25 basis points. Most recently, for example, Latvijas Banka Governor Mārtiņš Kazāks told Bloomberg that the policy normalisation path meant that ‘we step-by-step gradually get to zero and then above’ and said that hikes of 25 bps ‘seem appropriate’ at the moment.
Perhaps tellingly, Kazāks was quick to add that hike size would be data-dependent. Moreover, moves of a mere 25 bps may not be compatible with some hawkish colleagues’ relatively ambitious view of where the ECB needs to get to by when, especially if inflation continues to surprise on the upside. Austrian National Bank Governor Robert Holzmann, for instance, has already suggested 50 bps of hikes by the fall.
Moves of 25 bps are a sort of default option for major central banks when hiking or cutting interest rates and the most common size of policy steps in normal times. These are not normal times, and the Bank of Canada boosted its target for the overnight rate by half a percentage point last week, while the US Federal Reserve, expected to take a 50-bp step soon, may even consider a hike of 75 bps.
In the case of the ECB, officials are given to reiterating that there is not much basis for trans-Atlantic comparisons. Still, a somewhat larger first step would make for a particularly clear signal that the ECB was taking high inflation seriously, an argument that until recently underpinned Holzmann’s failed push to invert the traditional policy sequencing and hike before ending net asset purchases.
Amid rising concern about how reliably inflation expectations are anchored, the Austrian governor’s reasoning could carry greater weight in this context than it did earlier in the other.
Another advantage of a 50-bp hike right at the get-go would be that it would put an end in one fell stroke to negative interest rates by bringing the ECB’s deposit facility rate [DFR] to exactly zero.
One insider who spoke to Econostream, though defending a 50-bp step as not inconsistent per se with the ECB’s mantra of gradualism, conceded that it was ‘definitely not the baseline’ for now.
‘But those people who would like to see more [of an increase in rates] will discuss this option, because they would like to get rid of the negative rates’, he said. ‘And you can do that by just increasing the MRO [main refinancing operations] by 25 [bps] and the DFR by 50.’
The latter point made by this person with respect to the spread between the DFR and the rate applied to MROs offers another potential justification for a relatively bold lift-off, as the larger the hike of the DFR, the greater the leeway when simultaneously adjusting the MRO.
Under fixed rate tenders, as MROs are currently conducted, the spread from May 2009 until May 2013 was a steady 75 bps, but was reduced in the wake of a zero DFR to a low of 25 bps between November 2013 and September 2014, subsequently widening again as the DFR went ever more negative. It now stands at 50 bps.
One policymaker alluded to ‘interesting expectations now on the markets that there might be a lowering of the spread between the DFR rate and the MRO rate, that actually even if we go up with the DFR rate 75 [bps in total this year], that would mean just 50 for the MRO.’
Fine-tuning the spread ‘will be also on the table’ of the Governing Council, he said. ‘Actually, I expect that [different key interest rates will be adjusted differently], since we are starting to normalise. Nobody can expect that we will go back to 5% or 6%, and in that case it makes more sense for me to have a bit narrower band between the rates and then be gradual up and down. So, I would say that in the normalisation phase we will narrow the spread’ between the DFR and the MRO.
This person left open the question of ‘whether it will be in the first move or the second or the third’, as it remained too early to say.
As Econostream understands, a total of 75 basis points of rate hikes between now and the end of the year, which is consistent with what financial markets currently envision, would make it somewhat more likely, but still not the baseline as of today, that the ECB would opt to act in two steps of 50 bps and 25 bps, respectively.
In any event, the ECB would not spring a 50-bps move on markets, according to an insider: ‘I don’t think they will announce it without at least hinting to the market that something similar can happen.’
This person rejected the argument that a 50-bp hike of the DFR would lead doves to argue that the one hike already constituted normalisation and that anything more would be tightening. The ECB has at times tried to distinguish between the mere normalisation it has finally - more or less - embraced, versus actual tightening, which it suggests it intends to avoid.
‘It depends on how you define what is normal, because there’s huge uncertainty now about what the natural rate of interest in this kind of scenario is, so people feel that negative rates are not normal, but it doesn’t mean that just going back to zero means we’ve reached equilibrium’, he said.
‘It is always a case of tightening if you go up with the rates’, he continued. ‘You can call it normalisation, but it’s always a tightening, because the change is important. … Even when we stop net purchases, this is also a tightening, even if we just call it normalisation.’