ECB Meeting Account Says 50bp Hike Demonstration of Council’s Ability to React to Changed Outlook
25 August 2022
By David Barwick – FRANKFURT (Econostream) – The account of the European Central Bank’s policy meeting of 20-21 July, released by the ECB on Thursday, confirmed the substantial support of the Governing Council for a rate hike of 50 basis points as a signal of ability to respond to altered circumstances.
According to the account, Chief Economist Philip Lane characterised his proposal to hike the ECB’s key interest rates by 50 basis points rather than the 25 that had been previously flagged and largely expected as correct, given worsened inflation risks and in view of the ‘reinforced support’ in the form of a new anti-fragmentation programme.
Lane argued that the faster-than-anticipated departure from negative territory would pave the way for the Governing Council to decide policy on the basis of information available at each meeting, without the constraint of forward guidance, the account said.
According to the ECB, ‘a very large number’ of Council members were in agreement with the suggested magnitude of the rate hike in the context of recently deteriorated inflation prospects. ‘Some’ of their colleagues preferred 25 basis points on the basis of previous communication and in the face of possible recession, but also so as not to create additional market uncertainty with a surprise move.
‘These considerations notwithstanding, it was maintained that the Governing Council had to demonstrate that it was willing and able to respond if the outlook changed’, the account said. Moreover, 50 basis points would actually offer more clarity and policy remain accommodative, it was argued.
As ECB President Christine Lagarde indicated at the subsequent press conference, the transmission protection instrument (TPI) played a significant role in the decision, ‘helping the Governing Council to proceed more decisively with the normalisation of monetary policy than envisaged at the June meeting.’
Indeed, in addition to its actual purpose, the TPI ‘was also perceived as necessary to enable the Governing Council to act more decisively to maintain price stability’, the account said.
The decision in favour of 50 basis points was apparently considered by at least some Council members to be frontloading – also in line with Lagarde’s reporting – rather than over-delivery, though the meeting account noted that in any case, the Council was not in a position to determine the terminal rate yet anyway.
Negative interest rates ‘were clearly no longer warranted in view of longer-term inflation expectations standing at or above 2% and the current high inflation numbers’, the account said. ‘Furthermore, it was argued that frontloading a 50 basis point increase in July would allow the Governing Council more flexibility in reacting to incoming data and proceeding with monetary policy normalisation at its future meetings.’
Support for the idea of setting policy from one meeting to the next was ‘broad’, the account stated, as forward guidance was seen as having outlived its usefulness and ‘excessively constraining the Governing Council’s optionality, flexibility and data-dependence, with the risk that the Governing Council would tie itself to decisions that it needed to reverse later when circumstances changed.’
In this regard, it was noted that forward guidance continued to apply in the context of the balance sheet of the Eurosystem, though the meeting account gave no indication as to when quantitative tightening would make it onto the Council’s agenda.
It was felt by one or more members that a 50-basis-point hike was consistent with gradualism, if the latter were understood to mean ‘proceeding step by step’, and that ‘optionality should take precedence over gradualism’ under the circumstances.
Further policy normalisation would continue to be governed by the principles of flexibility, optionality and data-dependence, the meeting account reported.
Although no significant second-round effects were determined to have occurred yet, the likelihood of these was seen as higher. ‘The risk was that, once wages started moving, they would keep increasing over the medium term, particularly in view of the higher persistence of inflation than observed in other major currency areas’, the account said.
Longer-term inflation expectations were seen warranting monitoring, and it was noted that the Survey of Professional Forecasters had registered a new all-time high of 2.2%, with the growing share of respondents at the top of the distribution ‘seen as an early warning sign of further shifts in the mean.’
Weaker demand over the medium term could reduce inflationary pressures, but someone also countered this view, arguing that even if the euro area went into recession, upside risks could persist. ‘In this respect the behaviour of the unions in response to a recession was seen as crucial’, the account said.