ECB Meeting Account: Very Large Number of Council Members for 75bp, Policy Still Expansionary

6 October 2022

By David Barwick – FRANKFURT (Econostream) – The account of the European Central Bank’s policy meeting of 7-8 September, released by the ECB on Thursday, indicated that a rate hike of 75bp was favoured by a high number of Governing Council members and seen as still leaving monetary policy expansionary.

According to the account, ‘all members joined a consensus’ that included the 75bp hike, a reiteration of the ECB’s data-dependence and that the outsized hike should not be taken to imply any intention by the ECB ‘to agree on interest rate increases of a similar magnitude at its future meetings.’

Initially, a preference for 75bp – in accordance with Chief Economist Philip Lane’s proposal – was shared by ‘a very large number’ of Council members as ‘a proportionate response to the further upward revisions to the inflation outlook and an important signal that the Governing Council was determined to bring inflation back to its 2% target in a timely manner.’

It was noted that financial markets were assuming the ECB would move by more than the 50bp of July.

‘Since the deposit facility rate was, at 0%, far from a level that could be considered neutral in terms of monetary policy accommodation, and in view of the worse inflation outlook, progress towards a level that supported a return of inflation to 2% had to be frontloaded’, the account said.

Following the ‘important first step’ of 50bp in July, according to the account, ‘it was argued that policy would remain expansionary after a 75 basis point rate hike.’

As for the ‘some’ members who would have wished for a mere 50bp again in September (25bp being ‘clearly insufficient’), the larger option posed the threat of unnecessarily worsening the pending economic downturn, the account reported.

‘With the looming risk of a recession, which would mitigate inflationary pressures, an increase of 50 basis points, if part of a sustained path towards more neutral rate levels, might prove sufficient to return inflation to the Governing Council’s 2% target over the medium term once transitory shocks had faded’, the account said.

Those favouring 50bp argued that expectations remained anchored and wage growth moderate, with few signs of second-round effects.

‘Moreover, the size of the upward revision in the staff inflation projection for 2024 was not seen as sufficiently large as to require a more aggressive response, since it was uncertain how much inflation was likely to dampen domestic demand and high uncertainty surrounded the projections, particularly towards the end of the projection horizon’, the account said.

However, the account related, ‘[i]t was also widely felt that, at times of extraordinary statistical uncertainty around the baseline projections, the precise numbers foreseen for inflation at the end of the projection horizon mattered less than the assessment of risks, which were seen to be on the upside throughout the horizon, including over the policy-relevant medium-term horizon.

The Council saw a need to address the danger of greater bond market volatility by describing the decision for 75bp as a frontloading of policy normalisation, but at the same time, ‘it was considered important to indicate that interest rates would be raised further over subsequent meetings as part of the normalisation process’, the account said.

Key ECB interest rates were deemed at the meeting to be ‘still highly accommodative’, the account reported. ‘Inflation was far too high and likely to stay above the Governing Council’s target for an extended period’, it said. ‘It was therefore essential that it be brought back to 2% in a timely manner.’

In addition to taking note of the repeated upside inflation surprises, Council member apparently considered price pressures to be ‘unlikely to abate on their own’, the account said. The 2022 and 2023 HICP projections had been raised, ‘while the projection for 2024 had drifted upwards over the past few quarters and now clearly exceeded the Governing Council’s target of 2%.’

Moreover, risks throughout the medium term were predominantly to the upside, and ‘month-on-month figures for headline and core inflation were rising strongly’, the account said.

Demand was characterised as contributing to deteriorated inflation prospects, in which context it was warned against over-emphasising supply-side factors, lest the need be ignored for aggregate demand to adjust so as to restore price stability, the account said.

‘In this regard, it was maintained that the expected weakening in economic activity would not be sufficient to reduce inflation to a significant extent and would not in itself bring projected inflation back to target’, the account said. ‘This was seen to present the Governing Council with the difficult challenge of ensuring that inflation returned to target in a timely manner without unnecessarily exacerbating an economic downturn.’

Still, the argument was made that growth should not stand in the way of a strong rate hike to counter the increasing risks of second-round effects and a dis-anchoring of expectations, according to the account.

‘Against this background, the Governing Council’s response to upside deviations from the ECB’s target ought to be as forceful as it had been when inflation had been too low’, the account said. ‘It was recalled that the Governing Council regarded deviations of inflation from target in either direction as equally undesirable.’