ECB Insight: Convergence of Council to Smooth Road to Major Decisions, at Least for the Moment

17 May 2022

By David Barwick – FRANKFURT (Econostream) – In the context of the ongoing communications blitz being waged by members of the European Central Bank’s Governing Council, the convergence of views is hard to overlook and important not to underestimate.

The fact that positions among Council members are so visibly coalescing (as we noted eight days ago) well ahead of the critical meeting on which this will bear most directly implies a substantial hurdle that any potential divergent policy outcome would have to overcome to materialise.

For now: (1) there is no such alternative outcome in clear sight; (2) there appears little likelihood that circumstances will change to such degree as to foster the emergence of an alternative; and (3) though monetary authorities continue to express their views, perhaps creating the perception of a raging debate, there is a fair degree of clarity about the largest near-term questions on the path forward.

Item number one is the end to net asset purchases. Econostream’s assessment in this regard has only strengthened further in recent days: the ECB will with near certainty terminate net asset purchases in time to be able to hike rates at the July 21 Governing Council meeting.

At this point, it makes little sense to enumerate the supporters of ending net asset purchases within the next two months, there being so many. Even among those on the Council who are less clearly delighted about it, the resistance is muted, if resistance it is.

Indeed, we saw nothing akin to opposition from Banco de España Governor Pablo Hernández de Cos on Saturday, when he said he saw ‘a clear case for normalising monetary policy’ and that ‘most likely this will be the decision in our meeting in June for ending the APP in July’.

Similarly, Banca d’Italia Governor Ignazio Visco on April 28 called it ‘very likely that we may end … in June our purchases’. Chief Economist Philip Lane said on April 29 that ‘we’ve signalled our strong expectation that … this is coming up’, while his Executive Board colleague Fabio Panetta, perhaps less enthusiastically, confirmed on May 5 that ‘in the next few weeks we will decide when in the third quarter net bond purchases will end.’

None of them need be thrilled about the end of net purchases in order to accept it as appropriate under the circumstances, but the indications are that accept it they will, and we believe the Council stands a good chance of achieving unanimity on this point at its June 9 monetary policy meeting.

Item number two is, in Lane’s words, ‘the issue about moving interest rates.’ Looking around the Council, the story is to a significant extent the same as in the case of ending net asset purchases. That is, the widespread support for moving sooner rather than later is so conspicuous that one can spare oneself the exercise of listing the proponents.

That said, there may be lingering doubts on the question of a July versus a September lift-off, doubts a small minority of Council members would encourage. Notable among these is Panetta, who warned that ‘it would be imprudent to act without having first seen the hard numbers on GDP for the second quarter and to discuss further measures without a full understanding of how the economy could develop over the following months.’

If by ‘hard numbers’ he means the preliminary flash estimate, this information won’t be available until a week after the July 21 Governing Council. Quite possibly, his standard would be even higher, implying a ‘wait-and-see’ mode until Council members reconvene on September 9.

We consider the probability of a significant faction being willing to countenance such sustained inaction to be low, and observe that Panetta has a history of staking out more pronounced dovish positions than anyone else. At the same time, he is not reputed to thwart consensus, though arguably, this has not been put to a fair test, given the course of monetary policy the last couple of years.

Should he want to put up a fight, who would be in his corner? Visco, one of the most logical candidates, said that the ‘some time after’ of the ECB’s forward guidance ‘may be during the third quarter, it may be at the end of the year, and it has to be gradual.’

De Cos, another presumptive possibility, said that after ending net asset purchases ‘we will start to discuss and maybe soon increase rates. And this is fully compatible with the framework that we have, with the fact that we are observing inflation anchored at 2%, and that we therefore can and should normalise policy in that context.’

Even Bank of Greece Governor Yannis Stournaras on April 8 vowed that ‘we’ll do whatever it takes not to let inflation, a temporary inflation becoming a structural and permanent one.’

Our base case is that the ongoing convergence of the Governing Council with respect to the coming steps will lead to very broad agreement on a July rate hike. We do not even exclude that Panetta will ultimately get behind this decision.

Notwithstanding the perception of many market observers that Christine Lagarde is a relatively weak ECB president, it is worth noting that her most recent comments are consistent with our conjecture. Net asset purchases ‘should be concluded early in the third quarter’, she reiterated on May 11. Some time after that, which ‘could mean a period of only a few weeks’, would be lift-off.

We find particularly interesting her comment that ‘[a]fter the first rate hike, the normalisation process will be gradual’, as if she wished in effect to say that the initial increase in borrowing costs - on July 21, in our view - would follow hot on the heels of the end of net asset purchases at the end of June or in early July, but that rate hikes thereafter would take place at a more measured pace.

All this makes sense, and monetary authorities have gone out of the way recently to highlight their burgeoning unity. Despite ‘slight differences’ in public pronouncements, de Cos said on Saturday, ‘if you look at the statements of Governing Council members … since our last meeting, I think most of them or all of them are converging to one idea of when we are going to finish, ending our APP [asset purchase programme] and when we might increase rates for … the first time.’

That squares with Banque de France Governor François Villeroy de Galhau’s comment on May 6 that Council members’ ‘views are presently significantly converging’.

As such, we think it is very reasonable to expect that euro area monetary policy’s next few steps will be taken relatively smoothly despite their unusual significance. Beyond that, we suspect fault lines will re-emerge before long and the going will get tougher once again.