ECB Insight: At the Eurotower, Time to Deliver, Perhaps Even Over-Deliver

19 July 2022

By David Barwick – FRANKFURT (Econostream) – Perhaps the less edge-of-the-seat issue to be decided by this week’s European Central Bank monetary policy meeting, most seem to think, is the size of the first ECB rate hike in a decade, with 25 basis points widely seen as approaching but not quite reaching a certain inevitability.


We too consider this somewhat more likely. Compared to most, though, we are far from discounting 50 basis points, given the preference of some Governing Council members for such a move and assuming the ECB puts enough flesh on the bones of its new anti-fragmentation instrument –the more eagerly awaited outcome, more on that later - for it to believably eliminate obstacles to hiking in the form of an adverse market reaction.


The first reason has to do with our scepticism regarding the reasoning of nearly every observer to argue against 50 bp, which is that the credibility of the ECB’s communication is somehow at stake here, monetary authorities having repeatedly and recently indicated that it would hike by 25 bp in July. We think the ECB’s relationship with consistency is decidedly more elastic.


After all, is anyone in the Eurotower much troubled by Chief Economist Philip Lane’s insistence into January that a first rate hike was unlikely this year, or his affirmation on May 30, upended 10 days later, that ‘increases of 25 basis points in the July and September meetings are a benchmark pace’?


Maybe, but all we have is the words President Christine Lagarde eventually uttered by way of justification for her own repeated dismissals of a 2022 lift-off, and they could serve her just as well on Thursday as on February 3: ‘On the other question of the rate hikes: you know, I never make pledges without conditionalities and it is even more important at the moment to be very attentive to that.’


Of course the ECB would need to have a narrative to account for as flagrant an inconsistency as a 50bp hike on Thursday. Which brings us to our second reason for not dismissing this scenario, namely the ease with which it might be justified.


This has to do with facts on the ground, both known (for example, the euro’s weakness and, related to this, the ECB’s dilatory approach to normalisation amid other jurisdictions’ increasing aggressiveness) and potentially unknown (eg the SPF) to observers.


As a Council member told Econostream recently, ‘If one can really make the case that something has changed significantly from what we know now, then of course we could’ hike by more than 25 bp in July.


Recent surprises from the ECB have tended to be hawkish, and under the circumstances it is well short of impossible to imagine the ECB deciding that a surprise is either called for or perhaps simply unavoidable, the blackout having inhibited communication of a possible outcome that gained traction only relatively late.


More arguments could be made in favour of 50 bp – which could also be part of a compromise involving the new instrument - and we fully expect the hawks on the Council to make them when the time comes. In any event, the chances of this outcome are non-trivial, even if, on balance, we still assume – just – that all key rates will be hiked by 25 bp.


With respect to the next rate move, the ECB has little reason to depart from previous rhetoric concerning September, and as for 4Q, we keep in mind that various insiders who spoke to Econostream expressed the view that Lagarde’s pronouncements in June may have been overreaching, given the high uncertainty. Tying future hikes to the medium-term inflation outlook should be enough; we don’t expect precise guidance.


Neither should more precision about the neutral rate be expected at this stage. The ECB isn’t quite sure how far it is going, and Lagarde won’t want to encourage speculation about what Vice President Luis de Guindos has called the ‘landing zone’ by suggesting where neutrality lies.


As for the anti-fragmentation programme, we see the ECB as having a literally compelling interest in being able to convince markets that, despite all the fits and starts and even if some follow-up fine-tuning is needed, its arsenal has now been successfully complemented.


While we agree that previous commentary by Council members around this issue could warrant scepticism, we recall their tendency to stake out divergent positions publicly and then converge once around the table.


Banco de España Governor Pablo Hernández de Cos expressed it as follows publicly on May 14, and various insiders have told us the same:


‘Very often it is over-emphasised, the lack of consensus within the Council’, de Cos said. ‘Of course, we enter the room probably with different views, but then after the discussion … I have the perception that we convince each other and … we reach an agreement, which doesn’t mean that you are completely convinced. And this is why in public statements there might be slight differences.’


In this particular case, failure to deliver would be an emperor-has-no-clothes moment that the ECB can ill afford, meaning that Lagarde has to have considerably more than a programme name. We won’t embark here on what the details are likely to be, having written about this variously in recent weeks already. But details there will be, we firmly expect.


Lagarde won’t avoid making a comment on the euro, given its recent historic weakness. One question is whether the subject makes it into the introductory statement, albeit only as a partial explanation of persistent high inflation. This doesn’t happen often but seems quite reasonable under current circumstances.


More generally, some routine verbal intervention is not excluded, but serves little purpose. If the ECB wants to stem the tide, its main hope lies in a more resolute approach to monetary policy normalisation (50 bp, anyone?).