Exclusive: Many ECB Insiders Still Undecided, But Clear Potential for Compromise Involving 50 Bps
6 June 2022
- ECB insider: Gradualism is ‘a relative concept’, not an automatic objection to 50 bps
- ECB insider: Once Fed decided on 50 bps each meeting, obvious ECB must think about our steps
- ECB insider: Starting with 25 bps and then doing 50 would be ‘more gradual than 50 on the spot’
- ECB insider: ‘The relevant thing will be the path’ of rates, not so much each step
By David Barwick – FRANKFURT (Econostream) – When European Central Bank Governing Council member François Villeroy de Galhau said on May 16 to ‘expect a decisive June meeting’ of the Council, an agenda item he probably didn’t expect to dominate was the size of the ECB’s first rate hike since July 2011.
With mere hours left to the June 9 and 10 gathering in Amsterdam, however, for many observers this is the key open question, given that a blog post by ECB President Christine Lagarde two weeks ago and subsequent remarks by Chief Economist Philip Lane have left no reasonable doubt that net asset purchases will soon end and rates lift-off will follow with little delay.
Both Lagarde and Lane seemed intent for the moment on ensuring that the ECB would move in steps of 25 basis points, with the latter describing such a magnitude as ‘a benchmark pace’ for moves anticipated in July and September.
‘Any discussion about other moves would have to make the case for moving more strongly than this sequence of hikes in July and September’, Lane said. ‘The discussion will be had, but our current assessment of the situation, where we think the medium-term inflation outlook is in line with our 2% target, calls for a gradual approach to normalisation.’
Based on our conversations with insiders, objections to 50 basis points fell into two major categories.
The first of these sees, like Lane, a contradiction between a rate hike of that size and the much-vaunted principle of gradualism. By no means do all insiders consider this valid, however. Even when Econostream initially reported on April 21, when the idea was quite fresh, that 50 basis points would come up for discussion, we raised this very objection and it was rejected.
Much more recently, another insider also dismissed it, calling gradualism ‘a relative concept’.
‘Gradualism depends on the economic outlook, so under some circumstances, 25 basis points at every second meeting would be no question, and not unproportionate, and under other circumstances, 50 each would be still gradual’, he said.
‘So to me, gradualism is a relative concept which is more about timing in the sense that when you do things gradually, you have opportunities to react, also to how the markets and the economy and the inflation outlook respond to the moves’, he elaborated. ‘It gives you opportunities to be more flexible in each direction. So, I wouldn’t say that 50 basis points is not gradual. Under certain circumstances it is, and under others, it isn’t.’
This view is a useful reminder that gradualism isn’t the only consideration. It calls to mind what we wrote on April 4, namely that gradualism might at some point have to cede to data. Of course, Council members can differ in their interpretation of a given data set’s implications for policy, so abandoning the argument of gradualism will require a higher standard for some than for others.
For example, by the time of Lane’s comments on May 30, the chief economist would have had a good idea of how the ECB’s updated macroeconomic forecasts look. We don’t know for sure, but an insider from one of the major Eurozone member states has told Econostream that his country’s national 2024 HICP projection was revised up from March and that he was fairly certain that the corresponding figures were ‘going up everywhere.’
Perhaps that is why Lane’s attitude might be seen as surprisingly open-minded on the subject of 50 basis points. We note that Lane is one of the most dovish members of the Council and that only in January, he still deemed it ‘quite unlikely’ that the ECB would even regard the conditions for lift-off as met this year, let alone do anything about it.
And yet all Lane has done now is place the burden of proof on those calling for 50 basis points. That is hardly the same as slamming the door on the idea, especially since the hawks would have had to do some convincing in any event.
The second major category into which objections to 50 basis points fall, based on our conversations, has to do with the potential for such a move to cause market indigestion.
‘In terms of minimising the risk of surprises, the risk of turmoil in the markets, I would advocate 25 basis points’, one insider said.
To the extent the problem boils down to the risk of a surprise that leads to market turmoil, one solution is what the insider from our reporting on April 21 said at the time would be a prerequisite for 50 basis points: steering markets in the right direction ahead of time.
Another insider, speaking after Dutch National Bank Governor Klaas Knot first broached the idea of 50 basis points publicly, made the same point: ‘If Knot didn’t do what he did and it came by surprise, then I would certainly say that the risk of a market reaction would have been quite high, but now that it’s in the open, the risk from that side is diminishing.’
‘But to me, it was rather expected’, he continued. ‘Especially once the Fed said it would do 50 basis points each meeting, then it’s quite obvious that the ECB is going to question whether maybe we should do something that is a bit closer to what they are doing. So, it wasn’t a surprise.’
There is a great deal of overlap between the two arguments opposing 50 basis points; one might argue that they amount to the same thing. But precisely this may make it easier for the Governing Council to ultimately see its way through to a compromise involving the larger option.
For example, we are aware that one insider with understanding for both sides of the debate would favour starting with 25 basis points and then stepping up to 50. That suggestion, mentioned by Econostream to another insider who had declared 50 basis points ‘what I would call not gradual’ because ‘if you start with 50, it’s difficult to then change’, was seen by him as a possible compromise.
‘That is more gradual than 50 on the spot’, he commented.
Another insider also felt that 25 basis points in July and highlighting the possibility of 50 in September might make sense in terms of optionality.
‘We keep on getting data on wage developments and things’, he said. ‘If we see greater signs of second-round effects, then it becomes more and more natural to move faster. But on the other hand, if we see some pushback from energy prices, German GDP clearly being dropped once the gas pipelines are shut or something…’
Two insiders seemed notably keen in any case not to see the question of 50 versus 25 basis points get overblown, which also inclines us to think that the discussion may not be as ideologically charged as some observers suppose.
‘From a conceptual point of view, perhaps it doesn’t matter’, one said. ‘It is not an economic debate. It is a matter of where are you putting more weight - on the risk of financial market turmoil, on the risk of deviation of inflation expectations, and then there definitely can be an agreement: okay, so we do 50 and then we evaluate the situation and perhaps make the path flatter or make it steeper.’
This person observed that both the Bank of England and the US Federal Reserve had started their tightening cycles with smaller hikes before moving to larger steps.
‘Maybe we start with 25 and then move to 50, or we could go directly to 50 because we started later’, he said. ‘This is a matter of designing and compromise. But the critical point is, how soon do you want to get to the terminal rate and what is this terminal rate going to be - the natural rate, above the natural rate?’
‘I’m sure there is going to be a discussion, and let’s see who wins’, he added. ‘I am pretty sure anyway that the decision will be by unanimity, because the relevant thing will be the path.’
To be clear, Econostream is not calling the decision one way or the other. That is, notwithstanding the comments from Lagarde and Lane, we do not think moves of 25 basis points in July and September are a given, and – though the same could be said of 50 basis points - neither do insiders seem to.
As one insider said of Council meetings: ‘It’s not a one-man show and never has been … or even a two-man show. Certainly, the view that is agreed by the president and chief economist, it’s much easier to get a consensus on that one than on anything else. But certainly, they also need to understand what the mindset of the Governing Council is when they make a proposal. Because in principle there could be a vote, and I think they don’t want to be outvoted.’