ECB Insight: Growing Dissension, SVB Fallout Make Retreat to Data-Dependence More Attractive

15 March 2023

By David Barwick – FRANKFURT (Econostream) – In considering what this week’s meeting of the European Central Bank Governing Council will bring, we start from the observations that a 50bp hike this week across the board is probably a given despite the Silicon Valley Bank insolvency, putting the spotlight on the post-March policy outlook, and that the Council is showing signs of increasing polarisation.

Whilst one could find opposing views even during the early days of the hiking cycle, the lines have now become more clearly drawn than at any previous point. A few dovish Council members have flouted a seldom-violated convention by publicly expressing resentment at some colleagues’ unabated enthusiasm for more tightening.

This implies that the more concrete Thursday’s decision by the Council about what lies ahead, the less happy one faction is going to be, and the less likely that camp’s representatives will go on being the good soldiers they have been so far during the hiking cycle. In other words, the process of arriving at any precise forward-looking decision is set to turn at least a bit more arduous.

The ECB thus has an increased incentive to avoid to the extent possible the thorniest questions. These include the appropriate hiking pace going forward and in general how much more tightening is needed.

Given a certain trade-off here, President Christine Lagarde could aim for a compromise in which, to the extent the one question is answered hawkishly, the other gets a more dovish answer.

For example, she could (theoretically) indicate that the current 50bp pace is likely to be maintained in May, but at the same time offer no hint as to what to expect further out whilst also signaling that the ECB is increasingly aware of the need to start considering the risk of doing too much (the latter being a bone that might be thrown the way of the doves in any case).

There are a number of problems with this, including the additional SVB-related uncertainty, but the ECB was not in a good position anyway to provide as much guidance as this implies. However, that circumstance facilitates another outcome, just not one that involves going out on any limbs by repeating the conditional guidance of recent months or a variation thereof.

What we mean is that the ECB can neatly sidestep the pitfalls of trying to work out the details of its future policy actions now by embracing anew the data-driven, meeting-by-meeting approach it has nominally applied since ditching forward guidance.

This ‘the-less-said-the-better’ outcome is what we expect this week. It corresponds to the uncertainty of the current environment, leaves coming decisions up to coming developments and skirts needless confrontation.

All this is not to say that Lagarde is going to appear to be without bias. The direction of travel should remain up, and despite the recent public disharmony, there remains a high degree of consensus on the need to tighten further. We don’t see Lagarde trying to gloss over this to satisfy an increasingly vocal but still small minority ready to call it quits, unless the entire SVB fallout becomes so acute by Thursday that all bets are off.

As for the forecasts, we stick to what we reported on 24 February and on 1 March, namely that the revisions to inflation would not be huge and would show core inflation remaining an issue for policymakers. Bundesbank President Joachim Nagel has since also suggested that medium-term inflation projections would hold up well despite the decline in energy prices since those projections were issued three months ago.

We hesitate to believe that the matter around Silicon Valley Bank will overturn previous thinking at the ECB. Whilst naturally unable to exclude a future turn of events in this evolving story that would warrant a change in sentiment, at this point we think that Lagarde will argue that the matter has only limited relevance for the euro area banking system, though she will be keen to reassure that authorities are monitoring the situation.

Nonetheless, one indirect effect is the reinforcement of a meeting-by-meeting approach, which by definition is cautious and would allay revived concerns about vulnerabilities potentially lurking in the system on this side of the Atlantic. Making decisions only when the time comes would buy the ECB time to determine whether the SVB matter is indeed much ado about nothing or a crack that could yet turn into a fault line.

Then there is the repricing by markets. Whilst this probably occurred too late in the game to affect the revised macroeconomic projections to be unveiled Thursday, it could still be seen to pose some new risk to the ECB’s ability to restore price stability in timely fashion.

We don’t know how Lagarde will strike the balance between the latter development and heightened financial stability worries. It could induce her to err on the side of hawkishness if – as we suspect – the SVB episode is seen by the Eurotower as a tempest in a teapot that has undermined the ECB’s efforts unwarrantedly.

Alternatively, and under the impression of Wednesday’s turbulence in particular, it is easier to believe that she will prefer prudence, making it arguable that the ECB has yet another reason to play for time and let the dust settle by emphasising data dependency.

In other matters, the terminal rate is unlikely to be identified, and whilst it appears probable that the pace of balance sheet reduction will pick up after 2Q, it is too soon for such a decision now.

All in all, without SVB it would have been very possible - and from the ECB’s perspective probably desirable - that this week’s press conference would be rather uneventful. That is now less likely to be the case, but the need for especially careful communication raises the odds of a misstep by Lagarde or a misinterpretation by markets.