ECB Insight: The ECB Is Setting the Stage for a Pivot, But Uncertainty About the Timing Makes it Tougher
9 November 2022
By David Barwick – FRANKFURT (Econostream) – Whether or not the European Central Bank executes a monetary policy pivot as early as December, it seems hardly a matter of debate that its communication has already been laying the groundwork for one to come sooner or later.
We assume that the Governing Council is deliberately preparing for this eventuality rather than accidentally leading observers astray, even if the ECB’s need to carefully control the process is leading it to walk back some of what ECB President Christine Lagarde achieved, willingly or not, at the October 27 press conference.
But the pushback over the last week and a half, to the extent it has sought to dispel the notion of any change, hasn’t been convincing. Rather, one gets the impression that monetary authorities recognise that a pivot has to come fairly soon, but that the gusto with which they embraced policy normalisation after resisting so long has now come back to haunt them.
Much sooner than anyone would have anticipated just months ago, 200bp of tightening are already in the pipeline. Future policy moves have no choice but to take the lagged impact of this into account, but there is an understandable desire to quash any perception that monetary policy is about to go soft on inflation, which, after all, has not even peaked.
In the interview Econostream published on Monday with ECB Governing Council member Mārtiņš Kazāks, this ambivalence, in our view, was on clear display.
Whilst insisting that ‘there is no pivot’, he readily predicted ‘big discussions about 50bp, or 75, or whatever else’ in December; suggested that another policy tool could pick up some of the slack from a reduced hike; conceded that smaller steps would eventually become appropriate; and observed that ‘the situation is becoming more nuanced’.
Those comments are certainly among our reasons to think that something has changed, as is his reticence about his preferred size of the December rate hike.
For example, on 28 September, so with the October meeting still one month hence, he said that a move of ‘at least 50 basis points would be appropriate’. This willingness not so long ago to commit a month ahead of time seems to have given way to a more cautious approach.
Or consider the response of ECB Vice President Luis de Guindos when asked by Politico whether markets had applied too dovish an interpretation to Lagarde’s remarks. The latter, he said in anything but a ringing endorsement of her performance, ‘reflected the discussions and the debate that we had in the Governing Council.’
‘I think our communication was clear’, he continued. ‘Afterwards, you have interpretations and market reactions and, in the short term, markets sometimes overreact. However, I think a sort of correction followed the initial immediate reaction.’
There was no ‘yes’ anywhere in de Guindos’ evasive answer to a straightforward question.
The impression we have of an ECB preparing for a possible deceleration does not however depend on any of the above. October 27 is all we need to make our case.
In this respect, we would point to the new reference by Lagarde to ‘substantial progress’; the removal of ‘over the next several meetings’ from the previous declaration (‘over the next several meetings we expect to raise interest rates further’); and the suddenly explicit inclusion of the (weakening) economy as the basis, alongside inflation, of the future policy rate path.
We note that this is all from the monetary policy statement on which the entire Council signs off. A Lagardian misstep in the heat of the Q&A it was not.
But the Q&A only offered further evidence of a pivot, what with Lagarde’s introduction, presumably also not spontaneous, of ‘three key factors’ intended to explain ‘how we are going to work in the next meetings that we have.’ We find their dovish flavour unmistakeable.
The first factor was the inflation outlook, which, she noted, was also about ‘the evolution of the economy, including the higher likelihood of a recession.’ Measures already in the pipeline were another factor, in which context she hastened to underline that the ECB had already hiked by 200bp, and third was ‘the time lag that always affects monetary policy decisions.’
We look to the account of the meeting, to be published on 24 November, for potentially important insight into how Governing Council members viewed the need to prepare for a policy pivot and the extent to which they are divided on the subject. Reports seem to corroborate a growing reluctance of the doves to continue supporting or at least not too explicitly oppose very hawkish policy.
For a public example of this, one might consider recent comments by Banca d’Italia Governor Ignazio Visco, who a few days after the last monetary policy Council meeting warned that ‘the danger that the deterioration of the economic outlook will turn out to be worse than expected, making an excessively rapid step in the normalization of official rates disproportionate, should not be underestimated.’
‘This is a risk that the Council will have to take into account in the coming months, just like letting inflation remain excessively high for too long’, he said.
All in all, we see little basis for a debate as to whether the ECB is preparing a pivot, the evidence being overwhelming. The most we are willing to accept is that under current, very high uncertainty, the ECB is deeply unsure about the timing. We can imagine that a certain amount of feeling one’s way is unavoidable, and that incoming information, including apparent market overreaction, can lead to backpedalling or, as the case may be, to doubling down.
From today’s vantage point, with more than five weeks to go to the next decision, it is hard to rule anything out, though we would be most inclined to expect a modest reduction in the size of interest rate hikes in December, likely to be accompanied by the adjustment of another policy instrument or the announcement of specific plans for such an adjustment.
The adjustment, along with communication in general, would compensate to a high degree for the dovishness of the smaller rate hike, as the ECB is loath to seem to be donning the velvet gloves when it comes to inflation.