ECB Insight: Lagarde Confirms Two Hikes Coming Up, Dumps Water on Programme to Contain Spreads
23 May 2022
By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Monday confirmed that the Governing Council would hike rates in July and strongly suggested that a second rate hike would take place in September.
After that, she said, everything would depend on the situation.
‘…I expect net purchases under the APP to end very early in the third quarter. This would allow us a rate lift-off at our meeting in July, in line with our forward guidance’, she said. ‘Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.’
Lagarde has been saying for months that net purchases under the APP would end ‘early’ in the third quarter and has now – for the first time, Econostream believes – said this would in fact occur ‘very early’ in 3Q.
Econostream sticks to the view we last expressed on May 11, namely that this could mean that net purchases end at the end of June, but that in any case there would be little practical difference between that and the other outcome in which such purchases extended into the (‘very’) first part of July.
We anticipate that final clarity on this point will emerge from the Governing Council’s June 9 meeting.
‘The next stage of normalisation would need to be guided by the evolution of the medium-term inflation outlook’, Lagarde continued. ‘If we see inflation stabilising at 2% over the medium term, a progressive further normalisation of interest rates towards the neutral rate will be appropriate.’
However, she added, how quickly and how far further normalisation will proceed is unknown for now. We find this perfectly understandable given the extreme uncertainty of present circumstances, but also think that such a reservation corresponds to the ECB’s desire to ensure that markets remain calm as monetary accommodation is withdrawn.
Lagarde suggested that economic overheating would justify ultimately exceeding the neutral rate, but of course she does not have such a scenario in mind and continued with the observation that negative supply shocks were making it less clear how quickly inflationary pressures would subside.
‘In such a setting, there are arguments for gradualism, optionality and flexibility when adjusting monetary policy’, she said. Gradualism was justified by uncertainty, one consequence of which was that the neutral rate will only be recognised as such ‘once we get there’, she said.
‘This means that it is sensible to move step by step, observing the effects on the economy and the inflation outlook as rates rise’, she said. Is there, one might ask, some point at which the ECB, which has been extolling the merits of gradualism for some time, would not move step by step and evaluate the impact of its actions?
Econostream not being obliged to perform rhetorical gyrations, we would say simply that this appears to confirm that the first two rate hikes are going to be back-to-back – July and September, it would appear – while any hikes thereafter may take place at a more measured pace.
This hearkens back to Lagarde’s comment on May 11: ‘After the first rate hike, the normalisation process will be gradual.’ We understood that – correctly, it would appear – to mean that lift-off would follow close on the heels of the end of net asset purchases and thus not be subject to gradualism, unlike those thereafter.
The attitude in the Eurotower now, not two weeks later, is thus apparently that not just the first one but rather the first TWO rate hikes will follow the end of net asset purchases in rapid succession, and that only thereafter will the ECB not simply pay lip service to gradualism.
Interestingly for us, Lagarde explicitly conceded that ‘there are clearly conditions in which gradualism would not be appropriate’, such as ‘higher inflation threatening to de-anchor inflation expectations, or signs of a more permanent loss of economic potential that limits resource availability’.
In such a case, she said, ‘the optimal policy would become the same as for a demand shock: we would need to withdraw accommodation promptly to stamp out the risk of a self-fulfilling spiral.’
This goes to what Econostream said way back on April 4, namely that the data take precedence over gradualism.
Similarly, Lagarde appeared to confirm the hunch we’ve voiced over the past months, for example on April 13, that a programme to keep sovereign spreads in check wasn’t a given.
‘If necessary, we can design and deploy new instruments to secure monetary policy transmission as we move along the path of policy normalisation, as we have shown on many occasions in the past’, she said.
That’s obviously a lot different than telling markets that the ECB is making progress on the creation of a permanent facility. And if that’s all Lagarde can do at this point, it doesn’t bode well for such a facility.