ECB’s Governing Council Likely Still Inclined to Hike Significantly at a Steady Pace

31 January 2023

By David Barwick – FRANKFURT (Econostream) – Rare is the European Central Bank Governing Council meeting devoid of suspense, and although the primary outcome of this week’s gathering – a 50bp hike of all key interest rates – seems a foregone conclusion, what kind of stage President Christine Lagarde will set for the subsequent meeting is well worth speculating about.


This notably includes the question of whether the ECB will retain its language of six weeks ago, when it said that interest rates still had ‘to rise significantly at a steady pace’ and thus suggested no less than three 50bp moves - a reading confirmed to Econostream the same day by a participant at that meeting and, more recently, by the account of the discussion released by the ECB.


A number of Council members have made no secret going into this week’s meeting of their attachment to this messaging and to setting policy consistent with it by hiking 50bp in March (a review of their comments can be found here). And it was mere days ago that President Christine Lagarde last confirmed the ECB’s current course, going so far as to reiterate December’s ‘significantly at a steady pace’ communication.


Although the ECB is perfectly capable of changing track, we would exclude another bout of capriciousness so soon after the Council already executed something of a 360 in December relative to October, itself a dovish spasm. At this point, the ECB would risk looking foolish if it abruptly jettisoned that tone, and we think it will by and large be retained.


We don’t think January’s euro area HICP will affect this much. Even – or, ironically, perhaps especially - if the outcome were unexpectedly subdued, the ECB would not want to feed speculation that it is ready to let up in its effort to restore price stability.


At the same time, we also don’t take a 50bp hike in March for quite as granted as financial markets seem to, even if it is our baseline scenario. Indeed, we have had mild reservations all along, due in part to comments made by the December meeting participant we refer to above. That person said then that ‘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 (an outcome that now looks quite possible).


Moreover, we would also observe that Lagarde, possibly mindful of her own off-beam assurances that the ECB would not hike in 2022, was careful not to venture out too far on a limb this time around. Her exact words at the December press conference were:


‘Based on the information that we have available today, that predicates another 50bp rate hike at our next meeting, and possibly at the one after that, and possibly thereafter, but everything will also be determined by the review of data. So don’t assume that it’s a one-shot 50; it’s more than that. I don’t know how many more times.’


There was thus no promise of a 50bp hike in February, let alone in March, so the ECB, though it implied a degree of likelihood of such outcomes, remains officially uncommitted, and Lagarde’s vaguely worded divinations are far from being the kind of forward guidance that the Governing Council previously practiced. It follows that she can very safely recycle them on Thursday, leaving the door wide open to 50bp six weeks from now, but also leaving just enough room for the ECB to reach another decision.


The fact is that the ECB remains data-dependent, and even some of those Council members who want back-to-back 50bp hikes in February and March have made this clear, as the compendium we referenced above shows.


Whether the ECB will hike by 50bp in March may remain an open question beyond Thursday, but it can be debated whether anything about inflation has fundamentally changed for the worse, with policymakers continuing to describe expectations as more or less anchored and to deny any wage-price spiral.


To be sure, December euro area core inflation rose to 5.2% after two months of 5%, leading Executive Board member Isabel Schnabel to speak on January 10 of ‘a persistent build-up of underlying price pressures even as energy price inflation has started to subside from uncomfortably high levels.’ One can certainly agree that core inflation is key, as reflected in Council members’ recent comments on the subject (found here).


Even so, various Council hawks have refrained from positioning themselves clearly on the need for 50bp in March, with one of these indicating to Econostream a desire to see the updated staff forecasts due then before staking out a position. Banque de France Governor François Villeroy de Galhau is another one whose latest remarks would not be inconsistent with a further deceleration in March of the pace of tightening.


With the willingness of the doves to play along clearly fraying, March could bring the perhaps inevitable clash of wills.


For now, our central scenario remains for this Thursday to yield a 50bp hike and a December-type signal to expect the same again in March, and for March to bring another 50bp increase, after which the ECB can proceed with what it may call fine-tuning, meaning 25bp increments.


But again: relying on December’s communication once more in February – at most with a slightly clearer reminder of the ECB’s data-dependent, meeting-by-meeting approach – is perfectly consistent with our baseline, but also no impediment to an outcome we are less willing to rule out, namely a start of the fine-tuning part of the hiking cycle a little earlier than markets currently anticipate.