ECB Insight: Jockeying of Hawks Only Underscores Growing Likelihood of Council Rift
19 January 2023
By David Barwick – FRANKFURT (Econostream) – The new year does not appear to have brought any change in European Central Bank Governing Council hawks’ ability to dominate the public discourse, even if their recent comments don’t offer policy insight as much as they reflect the risen probability of a greater split in the ranks down the road.
ECB Governing Council member Francois Villeroy de Galhau provided an example of this on Tuesday when he spoke to French business news channel BFM Business.
‘The good resistance of the economy today gives us the means to raise interest rates in a pragmatic and reasonable way and thus to beat inflation’, he said.
Leaving aside the fact that ‘pragmatic and reasonable’ is subject to so much interpretation as to approach meaninglessness, Villeroy wasn’t the first to draw his conclusion, one of his peers having made a similar point to Econostream last week.
GDP is not the target of monetary authorities’ price stability mandate, but one could reasonably associate more persistent price pressures with an economy that is humming along and on that basis draw a line of sorts from economic resilience to a greater need for rate hikes.
However, if improved prospects reflected, for example, an easing of previous supply constraints, then lower inflation and a brighter economic outlook could instead go hand in hand.
That said, neither Villeroy nor his colleague were speaking from an economic theory perspective, but rather practicing the Realpolitik of Eurotower policymaking. Though the latter explained himself more explicitly – speaking as he was on background - both see robust economic developments as giving the ECB freedom to raise borrowing costs by curtailing room for blowback.
We regard such comments as mostly positioning aimed at those likeliest to stand in the way of further rate hikes.
Although Council doves such as Bank of Greece Governor Yannis Stournaras have been good soldiers so far, the 250bp of tightening to date has understandably dulled their appetite for additional rate increases, and another 50bp in February is bound leave some at the outer limits of satiety.
It is no secret that a growing lack of enthusiasm on the part of certain Council members to support interest rates above the neutral level has set the stage for an increasingly sharp debate at policy meetings.
A clearer materialisation of the ECB’s downside scenario might have strengthened the hand of those opposing monetary policy action out of fear of ‘destabilising output’, as Stournaras expressed it already last summer.
Though Stournaras in a commentary in a Greek newspaper three weeks ago dutifully adopted the terminology of his peers about interest rates still needing ‘to rise significantly at a sustained pace’, and other doves have also been toeing the line, we think that President Christine Lagarde has bought the ECB time only until the February 2 policy meeting.
On that occasion, a 50bp hike seems assured, barring some very unexpected development in the next two weeks.
The March 16 meeting is another kettle of fish.
The above-referenced comments by Villeroy - suggesting to the doves that a leading argument of theirs may outlive its usefulness - speak to our expectation of a coming row. They do not, to our mind, say much about policy outcomes and merely underscore that the gap between the two sides could soon widen to a chasm.
In terms of policy outcomes, we think his comments on Wednesday in a LinkedIn post are more relevant to where monetary policy is headed post-February 2.
With respect to inflation, he wrote there, ‘we have seen encouraging signs in the last two months in France and the euro area with a stabilization or even a downward trend. We should reach the peak of headline inflation and probably core inflation in the first half of 2023, but this will only be a step, and certainly not the end of the fight against inflation.’
That the fight won’t end merely means that rates will persist at their terminal point for a period. As for reaching the terminal rate, Villeroy has been vocal about the need for core inflation to peak for this to happen.
‘As long as underlying inflation has not clearly peaked, we shouldn’t stop on rates’, he said on November 7, for example. A clear peaking of core inflation would be a ‘favourable condition’ for an interruption of rate hikes, he said on November 15 and again the following day.
We think those are more important comments than the jockeying for position that both sides engage in but which hawks have dominated for some time. By the same token, De Nederlandsche Bank Governor Klaas Knot’s comments today also leave us unimpressed.
True, Knot saw ‘multiple’ 50bp hikes, which would seem to suggest more than two and thus include March. But when asked explicitly whether this was so, he could only say that the phase of 50bp moves 'will not stop after a single 50bp hike - that's for sure.'
Of course, Knot would like to see three such hikes, if not more. We are saying merely that his uncertainty as to what will materialise post-February 2 is evident between the lines.
As for Lagarde herself, none of what she said today calls into question the above. Her admonishment to financial markets ‘to revise their positions’ we tend to dismiss as jawboning motivated by a desire to see markets do the ECB’s tightening for it.
Villeroy, Knot and Lagarde all saw the need to take their respective stand in response to the report earlier this week that a 25bp hike in March was gaining traction.
Whilst we are far from wanting to call a decision two months hence, we find speculation about a possible post-February deceleration quite reasonable and no less credible than those whose chain it appears to have rattled most. We interpreted Bank of Finland Governor Olli Rehn’s comments on Monday in this vein of uncertainty, and think that what a Council member told Econostream on December 16 is at least as true now as it was then.
Although ‘it’s quite clear that in February were going to have 50’ bp, that person said, ‘in March, I won’t be surprised when somebody starts asking, “Why 50?”’, especially if the staff projections remain unchanged or show any improvement in the inflation outlook.
In the end, policymakers’ enduring insistence behind the rhetoric on a data-driven, meeting-by-meeting approach suggests that March’s outcome will depend, as it should, on information not yet available. But the potential for the doves to win one at long last as the Council splits more widely can’t be overlooked, and the hawks are reacting to that.