ECB Insight: Kazāks Gets Behind a July Lift-Off as a ‘Better Option’ than September

26 April 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Mārtiņš Kazāks on Tuesday positioned himself in favour of a July rate hike rather than for the next-best option of a September lift-off.

‘A rate rise in July is possible and reasonable’, he told Reuters. It would not make a great difference whether lift-off occurred in July or September, ‘but I think July would be a better option.’

It would thus appear that Kazāks has returned to his pre-war hawkishness. A week after the outbreak of hostilities, he had been notably less confident about the way forward, telling Econostream on March 2 about a 2022 lift-off that ‘[i]t’s still too early to say, but the increased uncertainty makes me more cautious.’

Financial markets were never quite as cautious, and as Kazāks noted, are currently pricing in up to three 25-bps hikes by end-2022. This, he said, was ‘quite a reasonable view to take.’

In light of financial market expectations as well as similar comments last week from ECB Vice President Luis de Guindos, Kazāks has by no means gone out on a limb with today’s remarks. De Guindos said that a rate hike in July ‘will depend on the data we see in June’ and that ‘[f]rom today’s perspective, July is possible and September, or later, is also possible’.

Between Kazāks and de Guindos, the public debate about the timing of an initial rate hike is in full swing. That July plays an important role in this debate is no surprise; Econostream for example pointed out on April 12 that ‘some governors favour July’.

Although a sense of urgency about the need to normalise policy would be part of any argument in favour of July, there is the issue of how to time things properly in the context of forward guidance and the ECB’s mantra of gradualism.

Net asset purchases, it seems safe to assume, will end in July at the latest. Kazāks opined that ‘early July is appropriate’, but more importantly, ECB President Christine Lagarde has now repeatedly said with regard to ending net purchases in 3Q that - as she stated again Sunday - there is a ‘high probability that we do so early in the third quarter’.

It was always apparent that this was an option. Econostream sticks to its assessment of March 11 that purchase volumes could even be zero already as of July, depending on incoming data. We don’t think this is indefensibly inconsistent with the ECB’s stated intention of ending net purchases in 3Q, as the end could be defined as that month – or other period – in which such purchases reach and remain at zero. The ECB has the option in any case of declaring an end when it sees fit, making this a point one need not get hung up on.

Moreover, whilst the duration of asset purchases has often been spoken of in terms of months, the ECB’s hands are not tied in this regard. Both in March, when she announced – conditionally - that the ECB would end net purchases in 3Q, and in April, when she confirmed it, Lagarde noted that a quarter has three months, but did not say – and was not asked – whether net purchases could, for example, end in the middle of a month. She did however say that the Council was ‘open-minded as to when in the quarter’ it would end the purchases.

Assuming data continue to be consistent with not deferring unduly a normalisation of policy, then clearing the way for a July 21 rate hike seems more prudent than the alternative of waiting all the way to September 8, at least if the ECB wishes to appear serious about heading inflation risks off at the pass.

Although September has the putative advantage of updated macroeconomic forecasts, that is a double-edged sword. If data between now and July argue for raising borrowing costs, then waiting another seven weeks beyond July for projections that could turn out to reveal medium-term price stability to suddenly be at stake would be regarded as foolhardy.

The distribution of costs associated with moving in July or September is probably not symmetrical, because in the scenario that September’s revised forecasts remain consistent with June’s and indicate medium-term price stability (we assume a significantly weaker outcome to be unlikely), then the ECB will have gained little by waiting until September to act further on its stated commitment to policy normalisation.

Forward guidance is no obstacle to a July rate hike. We quote Lagarde again: ‘Clearly, “some time after” is all-encompassing’, she said on March 10. ‘It can be the week after, but it can be months later, and by that I think we want to indicate that the time horizon is not what is going to matter most. It's the data that will support the decision that is made by the Governing Council to assess the medium-term inflation outlook and whether a rate hike is warranted.’

There is the matter of gradualism and the question of whether a rate hike in July, given an end to net asset purchases at the tail end of June at the earliest, is truly ‘gradual’. But forward guidance takes precedence, and the ECB won’t be shy about casting aside its gradualism – as we wrote on April 4 - even if it preaches the latter principle’s importance right up to the day of the first hike and beyond.

One wildcard in all this is the subject of rate hike size. It is not excluded that a compromise between hiking 25 basis points in July and waiting until September for lift-off could be a larger rate hike in September. Policymakers’ discussions have yet to get to this, but will eventually do so, as we reported on April 21.

The other big unknown is how data will turn out. Another upside inflation surprise for April, information due in a few days, would likely generate more momentum behind arguments for a July lift-off, though some might still want to wait and see what May and - as de Guindos implied - June bring.