ECB Insight: Only a Question of Time Before Someone at the ECB Suggested 50 Bps Publicly

17 May 2022

By David Barwick – FRANKFURT (Econostream) – It was only ever a matter of time before someone from the European Central Bank’s Governing Council publicly floated the potential need for the ECB to consider an outsized interest rate step. That Klaas Knot took it upon himself to do so is no shocker.

Outspoken by nature and easily one of the most hawkish members of the Council, Knot was among the first to advocate hiking rates in general, suggesting at the tail end of last year that ‘the policy rate could go up in early 2023’ and then escalating in early February to the view that ‘our first interest rate increase will take place around the fourth quarter.’

As Econostream wrote almost a month ago, the Council wil need to discuss the possibility of a 50-basis-point move. It was then neither the baseline nor necessarily destined to become it, all of which remains the case today.

On May 8, Executive Board member Frank Elderson appeared to confirm that the issue would at least make it onto the agenda, though he offered no assessment of his personal expectations or preferences.

Knot, who on a Dutch television show on Tuesday endorsed a July rate hike in line with financial market expectations, said that ‘[b]ased on current knowledge, my preference would be to raise our policy rate by a quarter of a percentage point.’

Given residual concerns about a policy misstep, not to mention fears of triggering market tensions, it is only natural that the hawks would not press their current advantage too vigorously and hamstring what should otherwise be a very broad consensus, potentially even unanimity, about a July lift-off.

Knot is already on record from February 6 as having advocated steps of the usual size, observing that ‘normally we take interest rate steps of 25 basis points ... and I have no reason to suppose that we will take any other step than that.’

Today, he was thus cautious about introducing a bolder scenario. If ‘new incoming data in the next few months suggests that inflation is broadening further or accumulating’, he said, ‘a bigger increase must not be excluded either. … in that case, a logical next step would amount to half a percentage point.’

Knot is not the only one on the Council likely to be amenable to the idea. Whether it comes to such a move is another question, and we continue to see very limited evidence that it could become the baseline absent yet more alarming inflation data. Indeed, as a first step, we would regard 50 basis points at the moment with scepticism.

To be sure, there may be advantages to lifting off strongly and thus immediately putting an end to negative interest rates, thereby sending a clear signal that the ECB has finally turned serious about keeping inflation under control.

It stretches imagination however to think that this would not exceed the limits of the recent pliability of Governing Council doves.

Another view that may gain traction is that such a move is best kept in reserve anyway. Assuming markets take an initial, standard increase in borrowing costs in stride, a subsequent 50-bps move – naturally on the condition of further upside inflation surprises and perhaps a revision of Eurosystem staff projections showing medium-term price stability at least attained if not exceeded – could make more sense.

Although Econostream is sceptical about the desire of some at the ECB to devise an instrument that would keep spreads in check, progress over time in this regard could also mitigate opposition to a more audacious rate hike.

If nothing else, Knot’s comments on the subject of rate hike size may make it easier for others to voice support for the idea. In the end, data will decide.